Chapter: 4 LITERATURE REVIEW

Non-Performing Assets of Banks

The future of banking will undoubtedly rest on risk management dynamics. Only those banks that have efficient risk management system will survive in the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for long-term success of a banking institution. Credit risk is the oldest and biggest risk that bank, by virtue of its very nature of business, inherits. This has however, acquired a greater significance in the recent past for various reasons. Foremost among them is the wind of economic liberalization that is blowing across the globe. India is no exception to this swing towards market driven economy. Competition from within and outside the country has intensified. This has resulted in multiplicity of risks both in number and volume resulting in volatile markets. Credit Risk, that is, default by the borrower to repay lent money, remains the most important risk to manage till date. The predominance of credit risk is even reflected in the composition of economic capital, which banks are required to keep a side for protection against various risks. According to one estimate, Credit Risk takes about 70% and 30% remaining is shared between the other two primary risks, namely Market risk (change in the market price and operational risk i.e., failure of internal controls, etc.). NPAs are the primary indicators of credit risk. NPAs are an inevitable burden on the banking industry. Hence the success of a bank depends upon methods of managing NPAs and keeping them within tolerance level, of late, several institutional mechanisms have been developed in India to deal with NPAs and there has also been tightening of legal provisions. An asset becomes Non-performing when it ceases to generate income for a Bank. It is also defined as credit facility in respect of which the interest and/or installments of principal has remained past due for a specified period of time. The specified period of time is two quarters. An amount due under any credit facility is treated as past due when it has not been paid within 30 days from the due date. As a step forward towards international best practices and to ensure greater transparency, it has been decided to adopt the90 days overdue norm for identification of NPA s from the year ending March31, 2004 accordingly a NPA shall be a loan or an advance where: Interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan,

The account remains out of order for a period of more than 90 days in the respect of an Overdraft/ Cash Credit. The bill remains overdue for a period of more than 90 days in the case of bills purchased or discounted. Interest and/or installments of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes.

Any amount to be received overdue for a period of more than 90 days in respect of other accounts.

Categories of NPAs Banks are required to classify Non-performing assets further into the following three categories based on the period for which the asset has remained Nonperforming and the realisability of the dues: a) Sub-standard Assets b) Doubtful Assets c) Loss Assets

a) Sub-standard Assets: A sub standard asset was one, which was classified as NPA for a period not exceeding two years. With effect from 31st March 2001, a sub-standard asset is one, which has remained NPA for a period less than or equal to 18 months. Such assets will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. b) Doubtful Assets: A doubtful asset was one, which remained NPA for a period exceeding two years. With effect from 31st March 2001, an asset is to be classified as doubtful, if it has remained NPA for a period exceeding 18 months. With effect from March 31,2005, an asset would be classified as doubtful if it remained in the sub-standard category for 12 months.

c) Loss Assets: A loss asset is one where the Bank or external Auditors or the RBI inspection has identified loss but the amount has not been written off wholly. In other words such an asset is considered uncollectable and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value. The asset quality of the banks can be examined by considering the NPAs. These NPAs should be considered against not just total assets but also against the advances, cause the NPAs primarily arise. When NPAs arise, banks have to make provision for the same as per the regulatory prescriptions. When the provisions are adjusted against the Gross NPAs it gives rise to the net NPAs. Provisions reduce the risk exposure arising due to the NPAs to a reasonable extent as they ensure that the banks sustain the possible loss arising from these assets. Following are the ratios for measuring asset quality of banks: Gross NPAs/ Gross Advances Gross NPAs/Total Assets Net NPAs/ Net Advances Net NPAs/ Total Assets Provisions for loan losses/Gross Advances

Measures to Solve Problems of NPA The problems of NPA have been receiving greater attention since 1991 in India. The Narasimham Committee recommended a number of steps to reduce NPA. In the 1990's the Government of India (GOI) introduced a number of reforms to deals with the problems of NPA. Major steps taken to solve the problems of Non-Performing Assets in India:1. Debt Recovery Tribunals (DRTs) Narasimham Committee Report I (1991) recommended the setting up of Special Tribunals to reduce the time required for settling cases. Accepting the recommendations, Debt Recovery Tribunals (DRTs) were established. There are 22 DRTs and 5 Debt Recovery Appellate Tribunals. 2. Securitisation Act 2002 Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 is popularly known as Securitisation Act. This act enables the banks to issue

notices to defaulters who have to pay the debts within 60 days. Once the notice is issued the borrower cannot sell or dispose the assets without the consent of the lender. The Securitisation Act further empowers the banks to take over the possession of the assets and management of the company. The lenders can recover the dues by selling the assets or changing the management of the firm. The Act also enables the establishment of Asset Reconstruction Companies for acquiring NPA. 3. Lok Adalats Lok Adalats have been found suitable for the recovery of small loans according to RBI guidelines issued in 2001. They cover NPA up to Rs. 5 lakhs, both suit filed and non-suit filed are covered. Lok Adalats avoid the legal process. 4. Compromise Settlement Compromise Settlement Scheme provides a simple mechanism for recovery of NPA. Compromise Settlement Scheme is applied to advances below Rs. 10 Crores. It covers suit filed cases and cases pending with courts and DRTs (Debt Recovery Tribunals). Cases of Willful default and fraud were excluded. 5. Credit Information Bureau A good information system is required to prevent loans from turning into a NPA. If a borrower is a defaulter to one bank, this information should be available to all banks so that they may avoid lending to him. A Credit Information Bureau can help by maintaining a data bank which can be assessed by all lending institutions. The Indian banking sector is facing a serious problem of NPA. To improve the efficiency and profitability, the NPA has to be scheduled. Various steps have taken by government to reduce the NPA. Asset quality is one of the important parameters based on which the performance of a bank is assessed by the regulation and the public. Commercial banks and NPAs The origin of commercial banking can be traceable in the early times of human history. In ancient Rome and Greece, the practice of storing precious metals and coins at safe places and loaning out money for public and private purposes on interest was prevalent. In England, banking had it origin with the London gold smiths who in the 17th century began to accept deposits from the merchants and others for safe keeping of money and other valuables. As public

enterprise, banking made it first appearance in Italy in 1157 when the Bank of Venice was founded. Commercial banking in India began in 1770 with the establishment of the first joined stock bank, named Bank of Hindustan, by an English agency in Calcutta. Bu this bank failed in 1832. In fact, the, real beginning of the modern commercial banking in the country was made with the establishment of the Bank of Bengal in 1806. Later on, the Bank of Bombay and Bank of Madras was also set up in 1840 and 1843 respectively. All these banks were presidency banks:- They were partly financed by East India Company. In 1881, the first purely Indian bank that is Oudh commercial bank came in to being. It was followed by the setting up of the Punjab National Bank in 1894 and Peoples bank in 1901. The Swadeshi movement of 1905 encouraged the growth of the commercial bank in India. Commercial bank in India can be divided in to two groups: a. Public Sector banks All of them are scheduled; and b. Private sector banks.

The public sector bank in India has developed in four phases. a. The Imperial Bank of India was nationalized and renamed as the State Bank of India in 1995. b. Then, 8 former state associated banks were reconstituted into 7 subsidiary banks of the SBI which are now called the associate banks of the SBI c. On July 19th, 1969, 14 major commercial banks were nationalized. Again on 15th April 1980, 6 more commercial banks were nationalized. d. Regional Rural banks were established in 1974, which are 196 in number at present. Modern banks in India are joined stock banks. They are registered under the Indian companies Act. They are classified by the RBI into two categories: - Scheduled and non- scheduled. Scheduled banks are those banks, which are included in the second schedule of the RBI Act, 1934 and have a paid up capital and reserves not less than Rs. 5 lakhs. The operations of these banks are controlled and regulated by the Reserve bank. Non-scheduled bank in India" means a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949), which is not a scheduled bank". A well-developed banking system is a necessary pre-condition for economic development in a modern economy. Besides providing financial resources for the growth of industrialization,

banks can also influence the direction in which these resources are to be utilized. Banks play an important role in the development of country. It is the growth of commercial banking in the 18th and 19th centuries that facilitated the occurrence of industrial revolution in Europe. Commercial banks contribute to a countrys economic development in the following ways. a) Capital formulation b) Encouragement to entrepreneurial innovations c) Monetization of economy d) Influencing economic activity e) Implementation of monitory policy f) Promotion of trade and industry. g) Encouragement to right type of industrious. h) Regional development i) Development of agricultural and other neglected sectors.

Non-Performing Assets in Commercial banks The asset quality of the banking sector improved in 2010-11 over the previous year. The gross NPAs to gross advances ratio declined to 2.25 per cent in 2010-11 from 2.39 per cent in the previous year. The GNPAs, however, increased in absolute terms in 2010-11 over the previous year, though at a lower rate. The improvement in asset quality was visible in both private sector banks and foreign banks. Public sector banks, however, witnessed deterioration in asset quality in 2010-11 over the previous year. This was mainly due to deterioration in asset quality of the SBI group. Among the bank groups, SBI group reported the highest GNPA ratio followed by foreign banks in 2010-11. Foreign banks, however, registered a decline in gross non-performing loans in 2010-11 over the previous year During the year 2010-11, the banking sector has written off almost ten per cent of the outstanding gross non-performing loans (as at end-March 2010), which helped in limiting the growth of gross non-performing loans. The extent of write off was lower in 2010-11 as compared with the previous year; however, in comparison with 2008 and 2009, the ratio was on the higher side. This indicated that during the last two years, writing off of NPAs was an important factor in maintaining the asset quality of the banking sector at tolerable

levels. The percentage of outstanding GNPAs written off to total outstanding GNPAs (as at endMarch 2010) was particularly high for SBI group and new private sector banks. Recovery of GNPAs is another important component of asset quality management in the banking sector. During the year 2010-11, the banking sector recovered 57 per cent of the outstanding GNPAs (as at end-March 2010) through various recovery channels. Foreign banks reported the highest recovery percentage followed by nationalised banks. SARFAESI Act, Debt Recovery Tribunals (DRT) and Lok Adalats are different channels available for the banking sector to recover their NPAs. In 2010-11, there was 51 per cent increase in the number of cases referred to under the SARFAESI Act. Further, out of the total amount involved, more than one third was recovered in 2010-11. In 2010-11, the number of cases referred to DRT registered a whopping growth of 114 per cent over the previous year. Due to the speedy recovery in Lok Adalats, the number of cases referred to Lok Adalats is much more as compared with other channels of recovery. However, in 2010-11, the number of cases referred to Lok Adalats witnessed a decline over the previous year. Moreover, the percentage of amount recovered to amount involved was comparatively lower in Lok Adalats as compared with DRT in 2010-11, though there was an improvement over the previous year.