A REPORT ON -NPA IN BANKING
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A REPORT ON
NONPERFORMING ASSETSCHALLENGE TO THE PUBLIC SECTOR BANKS
INTRODUCTION 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 from 859,461.95crore to 1,079,393.81crore in 2003, 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 2003. 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 were 47,300crore 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.
RESEARCH OPERATION 1. Significance of the study The main aim of any person is the utilization money in the best manner since the India is country were more than half of the population has problem of running the family in the most efficient manner. However Indian people faced large number of problem till the development of the full-fledged banking sector. The Indian banking sector came into the developing nature mostly after the 1991 government policy. The banking sector has really helped the Indian people to utilise the single money in the best manner as they want. People now have started investing their money in the banks and banks also provide good returns on the deposited amount. The people now have at the most understood that banks provide them good security to their deposits and so excess amounts are invested in the banks. Thus, banks have helped the people to achieve their socio economic objectives. The banks not only accept the deposits of the people but also provide them credit facility for their development. Indian banking sector has the nation in developing the business and service sectors. But recently the banks are facing the problem of credit risk. It is found that many general people and business people borrow from the banks but due to some genuine or other reasons are not able to repay back the amount drawn to the banks. The amount which is not given back to the banks is known as the non performing assets. Many banks are facing the problem of non performing assets which hampers the business of the banks. Due to NPAs the income of the banks is reduced and the banks have to make the large number of the provisions that would curtail the profit of the banks and due to that the financial performance of the banks would not show good results The main aim behind making this report is to know how Public Sector Banks are operating their business and how NPAs play its role to the operations of the Public Sector Banks. The report NPAs are classified according to the sector, industry, and state wise. The present study also focuses on the existing system in India to solve the problem of NPAs and comparative analysis to understand which bank is playing what role with concerned to NPAs.Thus, the study would help the decision makers to understand the financial performance and growth of Public Sector Banks as compared to the NPAs.
2. Objective of the study Primary objective: The primary objective of the making report is: To know why NPAs are the great challenge to the Public Sector Banks
Secondary objectives: The secondary objectives of preparing this report are: 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.
2. Research methodology The research methodology means the way in which we would complete our prospected task. Before undertaking any task it becomes very essential for any one to determine the problem of study. I have adopted the following procedure in completing my report study. 1. Formulating the problem 2. Research design 3. Determining the data sources 4. Analysing the data 5. Interpretation 6. Preparing research report (1)
Formulating the problem
I am interested in the banking sector and I want to make my future in the banking sector so decided to make my research study on the banking sector. I analysed first the factors that are important for the banking sector and I came to know that providing credit facility to the borrower is one of the important factors as far as the banking sector is concerned. On the basis of the analysed factor, I felt that the important issue right now as far as the credit facilities are provided by bank is non performing assets. I started knowing about the basics of the NPAs and decided to study on the NPAs. So, I chose the topic “Non Performing Assts the great challenge before the Public Sector Banks”. (2)
The research design tells about the mode with which the entire project is prepared. My research design for this study is basically analytical. Because I have utilised the large number of data of the Public Sector Banks.
Determining the data source
The data source can be primary or secondary. The primary data are those data which are used for the first time in the study. However such data take place much time and are also expensive. Whereas the secondary data are those data which are already available in the market. These data are easy to search and are not expensive too.for my study I have utilised totally the secondary data. (4)
Analysing the data
The primary data would not be useful until and unless they are well edited and tabulated. When the person receives the primary data many unuseful data would also be there. So, I analysed the data and edited them and turned them in the useful tabulations. So, that can become useful in my report study. (5)
Interpretation of the data
With use of analysed data I managed to prepare my project report. But the analyzing of data would not help the study to reach towards its objectives. The interpretation of the data is required so that the others can understand the crux of the study in more simple way without any problem so I have added the chepter of analysis that would explain others to understand my study in simpler way. (6)
This is the last step in preparing the project report. The objective of the report writing was to report the findings of the study to the concerned authorities.
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 lending 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 15th April 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 them to 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 the recommendations 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 – with inter-national best practices Introduction of off-site monitoring system and strengthening of the supervisory framework 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 the authority 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 abolished and 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 substantially enhanced. 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 banks are the following: •
Opening up the banking sector for the private sector participation.
Scaling down the shareholding of the Government of India in nationalised banks and of the Reserve Bank of India in State Bank of India.
(c) Measures taken by the Government of India to provide a more conducive legal environment for recovery of dues of banks and financial institutions are: • • •
Setting up of Debt Recovery Tribunals providing a mechanism for expeditious loan recoveries. Constitution of a High Power Committee under former Justice Shri Eradi to suggest appropriate foreclosure laws. An appropriate legal framework for securitisation of assets is engaging the attention of the Government,
Due to this paradigm shift in the regulatory framework for banks had achieved the desired 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 to 11.18% 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% and 14.5% 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 recorded operating and net losses in 1992-93, all the 27 banks in the public sector showed operating profits and only two banks posted net losses for the year ended March 31, 2001. The operating profit of the public sector banks increased from Rs.5628 crore as on March 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.4317 crore 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 practices and the final accounts of banks are transparent and more amenable to meaningful interpretation of their performance.
WAY FORWARD RBI president recently recommended Indian banks to go for larger provisioning when 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 create an Investment Fluctuation Reserve upto 5 per cent of the investment portfolio to protect the banks from varying interest rate regime. He further added that one of the means for improving financial soundness of a bank is by enhancing the provisioning standards of the bank. The cumulative provisions against loan losses 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 only low 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 provisioning against loan losses as 30% of their gross NPAs and only 5 banks had provisions in excess of 50% of their gross NPAs. This is inadequate considering that some of the countries maintain provisioning against impaired assets at as high as 140%. Indian Banks should improve 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 corporate goal. 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 developed regulatory 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 internal readjustment to meet the emerging regulatory prescriptions. Though adequate transitional route 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 to 90 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 towards implementation 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, seem to have translated to any substantial improvement in customer service. It needs to be recognised 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 the global competition as also the competition from non-bank institutions. The profitability of the public sector banks is coming under strain. Despite the resilience shown by our banks in the recent times, the income from recapitalisation bonds accounted 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 from 0.54 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 1996-97 to 8.84 in 2000-01. Similarly, the spread (net interest income) as a percentage of total assets 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 have recorded far below the median RoA of 0.4% for 2000-01 in their peer group. Incidentally the 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 bank’s profitability. As you are aware, the stock of NPAs does not add to the income of the bank while at the same time, 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 non discretionary and non discriminatory compromise settlement schemes’ in 2000 and 2001. Though many banks tried to settle the old NPAs through this transparent route, the response 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. The moot point is if the underlying security was not realised over decades in many cases due to extensive delay in litigation process, should not the banks have taken advantage of the one time opportunity provided under RBI scheme to cleanse their books of chronic
NPAs? This would have helped in realizing the carrying costs on such non-income earning NPAs and released the funds for recycling. If better steps are taken placed in this connection then the performance of the Public Sector Banks can show very good and healthy results in the shorter period. To make the better future of the Public Sector Banks, the Boards need to be alive to 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 the year ended March 31, 2001. There is thus an imperative need for the banks to go for cost cutting exercise and rationalise the expenses to achieve better efficiency levels in operation to withstand declining interest rate regime. Boards of banks have much more freedom now than they had a decade ago, and obviously they have to play the role of change agents. They should have the expertise to identify, measure and monitor the risks facing the bank and be capable to direct and supervise the bank’s operations and in particular, its exposures to various sectors of the economy, and monitoring / review thereof, pricing strategies, mitigation of risks, etc. The Board of the banks should also ensure compliance with the regulatory framework, and ensure adoption of the best practices in regard to risk management and corporate governance standards. The emphasis in the second generation of reforms ought to be in the 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 has witnessed substantial growth and radical changes. As of March 2002, the Indian banking industry consisted of 97 Commercial Banks, 196 Regional Rural Banks, 52 Scheduled Urban 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 post independence 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 nationalisation of banks (1969) and the initiation of the economic reforms (1991). This section focuses on 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 the chairmanship of Mr. Narasimaham to make an assessment of the banking sector. The report of this committee contained recommendations that formed the basis of the reforms initiated 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 legal framework; and 5. 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, the operating 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 development of the economic liberalisation process was the opening up of a vibrant capital market in India, with both equity and debt segments providing new avenues for companies to raise funds. Among others, these two factors have had the greatest influence on banks operating in India to broaden the range of products and services on offer. The reforms have touched all aspects of the banking business. With increasing integration of the Indian 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 the asset and liability sides) and the environment they operate in is discussed in the following sections. 1.2 Reforms on the Liabilities Side •
Reforms of Deposit Interest Rate
Beginning 1992, a progressive approach was adopted towards deregulating the interest rate structure on deposits. Since then, the rates have been freed gradually. Currently, the interest rates on deposits stand completely deregulated (with the exception of 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 AssetLiability 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 the recommendations of the Committee on Banking Sector Reforms, the minimum CAR was further 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 more stability to the Indian banking system. 1.3 Reforms on the Asset Side •
Reforms on the Lending Interest Rate During 1975-76 to 1980-81, the RBI prescribed both the minimum lending rate and the ceiling rate. During 1981-82 to 1987-88. The RBI prescribed only the ceiling rate. During 198889 to 1994-95, the RBI switched from prescribing a ceiling rate to fixing a minimum lending rate. From 1991 onwards, interest rates have been increasingly freed. At present, banks can offer loans at rates below the Prime Lending Rate (PLR) to exporters or other creditworthy borrowers (including public enterprises), and have only to announce the FLR and the maximum spread charged over it. The deregulation of lending rates 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 competitive advantage 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 the 1990s, the figure rose to 53.5%, which during the post-liberalisation period has been gradually reduced. At present, banks are required to maintain a CRR of 4% of the Net Demand and Time Liabilities (NDTL) (excluding liabilities subject to zero CRR prescriptions). The RBI has indicated that the CRR would eventually be brought down to the 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 and SLR requirements implies an increase in the share of deposits available to banks for loans and 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. By increasing the amount of invisible funds available to banks, the reduction in the CRR and SLR 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 postliberalisation. 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 loss assets. On 1st April 2000, provisioning requirements of a minimum of 0.25% were introduced 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 norms for NPAs have also been tightened gradually. Since March 1995, loans with interest and/or installment of principal overdue for more than 180 days are classified as nonperforming. This period will be shortened to 90 days from the year ending 31st' March 2004. 1.4 Structural Reforms •
Increased Competition With the initiation of banking-sector reforms, a more competitive environment has been ushered in. Now banks are not only competing within themselves, but also with non-banks, such as financial services companies and mutual funds. While existing banks have 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 banks have established operations in the country. Competition amongst Public Sector Banks (PSBs) has also intensified. PSBs are now allowed to access the capital market to raise funds. This has diluted Government's shareholding, although it remains the major shareholder in PSBs, holding a minimum 51% of their total equity. Although competition in 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 likely to 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. The increasing efficiency of both the equity and debt markets has also accelerated the process of financial disintermediation, putting additional pressure on banks to retain their customers. Increasing competition among banks and financial intermediaries is likely to reduce the Net Interest Spread of banks. •
Banks entry into New Business Lines Banks are increasingly venturing into new areas, such as, Insurance and Mutual Funds, and offering a wider bouquet of products and services to satisfy the diverse needs of their customers. With the enactment of the Insurance Regulatory and Development Authority (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 to which, banks need to obtain prior approval of the RBI to enter the insurance business. So far, the RBI has accorded its approval to three of the 39 commercial banks that had sought 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 Financial Supervision (BFS) under the RBI was constituted in November 1994. The Board is empowered to exercise integrated supervision over all credit institutions in the financial system, including select Development Financial Institutions (DFIs) and Non Banking Financial Companies (NBFCs), relating to credit management, prudential norms and treasury operations. A comprehensive rating system, based on the CAMELS methodology, has also been instituted for domestic banks; for foreign banks, the rating system is based on CACS. This rating system has been supplemented by a technologyenabled quarterly off- site surveillance system. To strengthen the Risk Management Process in banks, in line with proposed Basel 11 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 across various 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 12 years, and is today a dynamic sector. Reforms in the banking sector have enabled banks explore new business opportunities rather than remaining confined to generating revenues from conventional streams. A wider portfolio, besides the growing emphasis on consumer satisfaction, has led to the Indian banking sector reporting robust growth during past few years. It is clear that the deregulation of the economy and of the Banking sector over the last decade has ushered in competition and enabled Indian banks to better take on the challenges 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 the shareholder's perspective. It is a measure of Accounting Profits per unit of Book Equity Capital. The ROE of Indian banks for the year ended 31st March 2003, was in the range of 14 - 40%; the median ROE. Being 23.72% for the same period. On the other hand, the global 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 interest rate 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 FY2003 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 levels of 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 is the 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 important for banks for two main reasons: Firstly, capital is viewed as the ultimate line of protection against any potential losscredit, market, or operating risks. While loan and investment provisions are associated with expected losses, capital is a cushion against unexpected losses. Secondly, capital allows banks to pursue their growth objectives; a bank has to maintain a minimum capital adequacy ratio in accordance with regulatory requirements. A bank with insufficient capital may not be able to take advantage of growth opportunities 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 ratio measures a bank's Profits per currency unit of Assets. The median ROA for Indian banks was 1.15% for FY2003. For the global benchmark banks, the ROA ranged from 0.05% to 1.44% 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%). The median 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 FY2003 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-recurring income/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 works out to be lower for Indian banks vis-a-vis the global benchmark banks for FY 2003. I have further analysed the effect of adjustment for trading income on the ROAs of both Indian Banks and the Global Benchmark Banks. Here, it must be noted that the global benchmark banks have a more diversified income portfolio as compared with Indian banks, and a decline in interest rate could have increased profitability of global benchmark banks indirectly in more ways than one. However, from the disclosures available in the annual reports of the global banks, it is not possible to quantify the impact of declining interest rates on their profitability (`thus, the same has not been adjusted 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 a ROA decomposition analysis. 1.6 Decomposition of Return on Assets •
Net Interest Margin Net Interest Margin (NIM) measures the excess income of a bank's earnings assets (primarily loans, fixed-income investments, and interbank exposures) over its funding costs. To the past, for banks NIM was the main source of earnings, which were therefore directly correlated with the margin levels. But with NIM declining significantly in 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 income continues to account for a significant share of the earnings of most banks. The median NIM for Indian banks was 3.16% for FY2003 and 3.92% for FY2002. The figures compare favorably with those of the global benchmark banks. Before drawing inferences on the NIM benchmarking results, three aspects must be considered, 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
Intermediation cost is a significant factor explaining the differences in NIMs across 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 intermediation cost, 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 operations of four banks earned higher NIMs vis-a-vis the median of Indian banks in FY2002 and FY2003. Of these four banks, three earned NIMs above 4%. This analysis strengthens ICRA's hypothesis that the external operating environment is an important factor while benchmarking NIMs. (b) Type & Quality of Assets The higher NIMs of US-based banks are attributable to their sharper focus on consumer loans and credit cards as compared with European banks. Also, the high NIMs of US banks are the cause for their comparatively high ROAs. To overcome the potential for higher provisions arising from its strategy of lending to riskier assets, a bank may charge a higher rate of interest to its borrowers (with a consequently higher NIM) than another 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 disclose their RWA values in their annual reports, and therefore, ICRA has not been able to use this 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 generate higher Non-Performing Assets (NPAs). As a result, its provisions & contingencies are also 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 the fund based business of banks may be obtained. ICRA defined adjusted NIM as Net Interest Spread (Net Interest Income less Provisions & Contingencies)/Average Total Assets]. The Net Interest Spread's for the global benchmark banks ranged from 0.14 to 2.10% for the financial year ended December 2002, with the median at 1.54%. The corresponding 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 International Accounting Standard, (IAS) provisioning for NPAs is based on management discretion, Whereas in India, the RBI defines the provisioning requirement for impaired assets as a function of time and security. An illustration of difference in accounting for NPA is that for 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 will converge 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 believes that 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 interest yields and consequently, the NIMs, southwards. Hence, banks are increasingly concentrating on non-interest income to shore up profits. In FY2003, the range of noninterest income for Indian banks (as percentage of average Total Assets) was between 1.01 and 3.00%. The median for Indian banks showed a moderate increase from 1.63% in 2002 to 1.77% in 2003. The non-interest 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 from the sale of investments are not lively to be sustainable, ICRA has benchmarked the pure fee 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 the study 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 total assets) reveals how expensive it is for a bank to maintain its fixed assets and human capital that are used to generate that income streams, The median Operating Expense ratio for Indian banks was 2.26% in 2003, 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 FY2003 and 10.66% for FY2002. The values of the Gross NPA ratio for FY 2003 range between 2.26 and 14.68%.Many global banks do not disclose 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 FY2003 and 5.39% for FY2002. The values of Net NPA ratio for FY 2003 for the global benchmark banks ranged between 0.37 and 7.08%. Most of the global 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 is marginally higher than that for the global benchmark banks. •
Efficiency Benchmarking ICRA studied the following parameters to assess the efficiency of Indian banks vis-à-vis their foreign counterparts: • Profitability per employee • Profitability per branch • Business per employee • Business per branch • Expenses per employee • Expenses per branch The business model of the global benchmark banks involves outsourcing of noncore activities. In the case of Indian banks, particularly those in the public sector, both non-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 banks in the following sections. We would like to highlight that several factors influence the results here, and caution needs to be exercised in arriving at inferences. E.g. comparing expenses per branch (or employee) for banks across different economies involves conversion of amounts to a common currency. The results depend on the conversion rates of foreign exchange used (e.g. USD per rupee or Euro per rupee). In this report, ICRA has used nominal rates of foreign currencies rather than rates based on PPP (Purchasing Power 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 with customers, such as, the Internet, telephone, debit cards, and ATMs. Therefore, results from benchmarking using parameters such as business per branch or expenses per branch (which are appropriate parameters to compare across banks that operate predominantly through branches) need to be appropriately interpreted in an exercise when we compare heterogeneous banks across different economies. •
Profitability per Employee The profit per employee figure for 17 out of the 21 Indian banks was in the range of Rs. 0.02 crore for the financial year ended March 2003. Most Indian banks posted higher profits per employee in FY2003 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 banks as well as higher profits by the banks. On an average, new private sector banks enjoy a higher increase in profitability per employee, as compared with their public sector counterparts. This may be attributed largely to the better technology that the new private sector banks employ, besides the advantage of carrying no historical baggage. As for the global benchmark banks, the profitability per employee for HSBC was robust at USD 0.12 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 the global 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 2003 and 2002, respectively. On an inter-temporal basis, profit per branch has been increasing gradually in the Indian banking sector. The growth in profit per branch for Indian banks is attributable to the overall increase in profitability in the banking industry. In the case of the foreign peer group, profitability per branch shows 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 1.62 million (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 revenues and 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 the year ended March 2003. 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 2003. As for the global benchmark banks, business per employee for HSBC was robust at USD9.71 million (Rs. 44.66 crore), while that for ABN AMRO Bank 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 branch for the year ended March 2003. In recent times, the deposit mobilisation for Indian Banks on a branch basis has witnessed a steady increase. The new private sector banks in India have led the way in this regard, because of the better use of technology. The highest deposit per branch stood at Rs. 103.24 crore in 2003 for a new private sector bank, as compared with Rs, 68.71 crore in 2002. The global benchmark banks mobilised more business per branch as compared with their Indian counterparts. Bank of America mobilised USD 88.9 million (Rs. 408.94 crores) for the financial year ended 2002, while ABN 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 respective countries. 3.5.5 Expenses per Employee For this analysis, ICRA has used the employee expenses per employee as a measure of the expenses per employee. Indian banks, on an average, expensed Rs. 0.025 crore 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 Group Inc. 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. 0.56 crore for FY2002. Over the years, Indian banks have reported a gradual increase in such expenses, with competition-prompted upgrade being the primary reason for the same. In the case of the global benchmark banks, expense per branch for Bank of America was USD 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 banking system and propagate best practices in banking across the world. For issues related to accounting, BIS has relied on the International Accounting Standards (IAS) issued by the International Accounting Standards Committee (IASC). Banks are supposed to follow these accounting standards as part of best practices. For the structural benchmarking study of the Indian banking sector, ICRA has used primarily the guidance notes issued by BIS and the relevant IAS as the benchmarks of best practices. ICRA has also referred to standards as mentioned under, US and UK. GAAP (Generally Accepted Accounting Practices) 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. To improve on the existing norms, BIS issued a Consultative Document in January 2001, proposing changes to the existing framework. The objective of this document is to develop a consensus on the Basel II Accord (as it is popularly known), which is expected to be implemented in 2007. Based on feedback received from various quarters, BIS issued a new Consultative Document in April 2003. In this document, BIS has proposed the 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 cent weighting. Under the new method, grades of weightings in the 20-150% range will be assigned. •
Introduction of charges for operational risks: Under the proposed Basel II Accord, banks have to allocate capital for operational risks. BIS has suggested three methods for estimating operational risk capitals: 1. Basic Approach, 2. Standardised Approach, and 3. 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 the Committee 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, 2003 has proposed new methods for estimating regulatory risk capital. To estimate 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 requirement on the basis of the external credit rating of borrowers. For nonrated borrowers, the RBI has asked the select banks to use the existing 100% risk weights. The RBI has also asked the banks to calculate operational risk capital separately following the Basel approach. Based on the result of the exercise, the RBI will issue new guidelines on estimating economic capital. Additionally, the RBI has asked banks to introduce internal risk scoring models. It is expected that once the Basel II Accord is signed, the RBI will allow banks to move to the IRB 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 recognised on the balance sheet. This includes all derivatives. Historically, in many parts of the world, derivatives have not been recognised as liabilities or assets on balance sheets. The argument for this practice has been that at the time the derivative contract was entered into, 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 International Accounting Standards. •
Valuation of Financial Assets IAS 39 has classified financial assets under four categories. The following table summarises 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 carrying amount of the financial asset with the present value of the currently estimated amounts and timings of payments. If the present value is lower than. The carrying amount, the loan is classified as NPL. Under US GAAP, loans assume non-accrual statuses if any of the following conditions are 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 the collateral is insufficient to cover the principal and interest. In India, NPAs are classified under three categories-Sub-standard, Doubtful and Loss 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 recognition effective 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 financial assets. A portfolio approach may be used for items that are individually small [IAS 39.109]. 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 on management discretion. Under US GAAP, when the Net Present Value of a loan is less than the carrying value, the difference is booked as provision. In India; provisioning norms are more explicit than they are under the IAS. RBI has specified norms for various classes of NPL as follows: Standard Assets: 10% Doubtful Assets: 100% of unsecured portion, 20-50% on secured portion Loss Assets: 100% Interest Accrual on M on-performing Loans / impaired Assets Under both IAS and US GAAP, there is no specific prescription for interest accrual 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 is identified as impaired, a bank should cease accruing interest in accordance with the terms of the contract. Interest on impaired loans should not contribute to net income if doubts exist 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 provisioning require; f tent of 0.2 5% on all standard assets. •
Conclusion The RBI norms for classification of assets, and provisioning against, bad/doubtful debts are more detailed and precise vis-a-vis international rules. While the international norms often leave bad debt provision levels to "management discretion", Indian standards are precise and clearly state exactly when and by how much reported earnings must be charged 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 are important factors in the development of a country's economy. Disintermediation affects the allocation process for both savings and credits in the economy. With the introduction of sophisticated deposit products by mutual funds, pension funds and insurance companies, individual and corporate depositors now have more options for savings. A similar trend is also visible in credit offerings. More and more corporate entities are now approaching 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, and life insurance plans, but not in bank deposits or other liability products. However, in continental 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 is likely to catch up with banks sooner than later. With the opening up of the financial sector, Indian banks are facing competition from the mutual fund and insurance sectors for savings. On the credit side, good quality borrowers have started raising debt directly from the market at competitive rates. •
Changing Capital Adequacy Norms Capital adequacy norms for banks are likely to undergo a change after the Basel II Accord 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 credit to a better quality corporate entity is likely to require less regulatory capital. The allocation of regulatory capital on the basis of credit quality would encourage banks to estimate their Risk adjusted Return on Capital (RAROC) rather than compute simple margins. Similarly, banks now need to distinguish between the credit qualities of sovereign borrowings and inter-bank borrowing, as they would need to allocate capital to sovereign credit and inter-bank credit on the basis of external ratings, or using the IRB approach. To emerge successful in the Basel II regulatory environment, banks would need to introduce 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, banks would 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 correlation amongst 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 and controlling Market Risk and Operations Risk. .3 Management of Non-Performing Assets 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 on two counts: The introduction of scientific credit risk management systems would lower slippage of assets from the performing to the nonperforming category. Further, banks with better NPA recovery processes would be able to reduce their provisioning requirements, 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 (SRES Act). Due to several cases still to be resolved in courts of law, it is. Not clear as yet, how far this Act is set to alter the NPA recovery scenario in India.
Following the announcement of the RBI's Asset Classification norms, the process of Asset Quality Management involves segregating the total portfolio into three segments and having detailed strategies for each. The three segments are: •
Special Mention Accounts/Sub-Standard Assets
Chronic Non-Performing Assets
Banks need to vigilantly monitor Standard Assets to arrest any account slippage into the non-performing grade. Besides, banks need to churn their credit portfolio so as to maximise returns while keeping the risks pegged at acceptable levels. Special Mention Accounts are assets with potential weaknesses which deserve close attention and timely remedial action. The typical warning signs exhibited by a borrower ranges from frequent excesses in the account to non-submission of periodical statements. Account restructuring and rehabilitation tools are best implemented during this stage. However, the challenges faced while restructuring include, (a) selecting the genre 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 the enactment of the SIZES Act. The Act provides the requisite regulatory framework for the foreclosure 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 include Enforcement of Security Interest, Securitisalion, One-Time Settlement (OTS), and Writeoff. However, a scientific approach to deciding which of these alternative routes must be taken 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 to settle outstanding dues. •
conclusion The profitability of Indian banks in recent years compares well with that of the global 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 build systemic 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 asset quality is minimised
Raise the share of non-fund income by increasing product offerings wherever 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 appropriate frameworks to measure risks, mitigate them or insuring them. The RBI as the regulator of the Indian banking industry has shown the way in strengthening the system, and the individual banks have responded in good measure in orienting them selves towards global best practices.
DISTRIBUTION OF THE INDIAN BANKS AS TO STATES AND POPULATION How Indian banks are distributed as to states and population is explained from the following table:
Table– Distribution of Banking Centers According to State and Population Group (As at The End of March)
Jammu & Kashmir
Chandigarh Delhi NORTH–EASTERN REGION Arunachal Pradesh Assam Manipur Meghalaya Mizoram Nagaland
Jharkhand Orissa Sikkim
West Bengal Andaman & Nicobar Islands CENTRAL REGION Chhattisgarh
Uttaranchal WESTERN REGION Goa
Dadra & Nagar Haveli
Daman & Diu
Kerala Tamil Nadu Lakshadweep Pondicherry ALL-INDIA
30268 30157 5051
MAJOR DEVELOPMENTS IN BANKING AND FINANCE •
The RBI allowed resident Indians to maintain foreign currency accounts. The accounts 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, in settlement 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 a view to liberalise gold trading, the Reserve Bank has decided to permit authorised banks to enter into forward contracts with their constituents like exporters of gold products, jewellery manufacturers and trading houses, in respect of the sale, purchase and loan transactions 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 without informing the central bank well in advance. Foreign banks have been further advised by the 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 subagents of money transfer service schemes. The RBI has allowed banks to invest undeployed foreign currency non-resident (FCNR-B) funds in the overseas markets in the long-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 by international agencies. The RBI has defined the term “willful defaulter” paving the way for banks to acquire assets of defaulting companies through the Securitisation Ordinance and reduce their 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 having adequate liquidity. International credit rating agency Standard & Poor has estimated that the level of gross problematic assets in India can move into the 35-70 per cent range in the 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, 2003. The Reserve Bank of India, as part of its policy of deregulating interest rates on rupee export credit, has freed interest rates on the second slab - 181 to 270 days for preshipment credit and 91 to 180 days for post-shipment credit with effect from May 1, 2003. The Cabinet cleared a financial package for IDBI and agreed to take over the contingent liabilities to the tune of Rs.2500 crore over five years. The IDBI Act will be repealed during the winter session of the Parliament, paving the way for IDBI’s conversion into a banking company.The IDBI would be given access to retail deposits, to enable it to bring down the cost of funds, but will be spared from priority sector lending and 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. Minimum investment of $10 million is required for setting up an OBU. All commercial banks are allowed to set up one OBU each. OBUs have to undertake wholesale banking operations and should deal only in foreign currency. Deposits of the OBUs will not be covered by deposit 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 and supervised by the exchange control department of the RBI. With a view to develop the derivatives market in India and making available hedged currency exposures to residents an RBI Committee headed by Smt. Grace Koshie, recommended phased introduction of foreign currency-rupee (FC/NR) options. _ The Reserve Bank of India has notified the draft scheme for merging Nedungadi Bank with Punjab 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 banks in 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 also increased Authorised Dealer’s 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 its equivalent.The Government has decided to dispose of UTI Bank as part of restructuring Unit Trust of India.Though the details in this regard is yet to be worked out, it has been decided 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 travel operators such as Eurorail and other rail/road and water transport operators in India, in rupees, without deducting the paymentfrom the travellers’ basic travel quota. The Reserve Bank of India (RBI) has banned banks from offering swaps involving leveraged structures, which can cause huge losses if the market moves the other way. The RBI constituted committee on payment system has recommended that the central bank, as the regulator of payment and settlement systems, should be empowered to regulate non-banking systems. •
Market Developments and New Products
The Hong Kong and Shanghai Banking Corporation will be bringing $150 million 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, 2003. 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 in a single shift.
The Canara Bank has returned 48 per cent (Rs. 277.87 crore) of its capital to the Government before its Initial Public Offer. China has granted licence to Bank of India to open a representative office in the south 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 customers to access their deposit accounts from ATMs and merchant establishments. The Siam Commercial Bank, having Thailand government as the major share holder, 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 India for 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 rural areas. This outfit would also extend agricultural loans.
CLASSIFICATION OF SCHEDULED BANKING STRUCTURE IN INDIA
The scheduled banks are divided into scheduled commercial banks and scheduled co operative banks. Further scheduled commercial banks divided into the Public Sector Banks, private sector banks, foreign banks, and regional rural banks. Whereas scheduled co-operative banks are classified into scheduled urban co operative and scheduled state co- 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 and new private sector banks. As far as the number is concerned, total public sector banks are 27, private sector banks are 30, foreign banks are 36, and regional rural banks are 196. 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 16 scheduled co-operative banks. Today the overall commercial banking system in India may be distinguished into:
1. Public Sector Banks 2. private Sector Banks 3. Co-operative Sector Banks 4. Development Banks PUBLIC SECTOR BANKS a. State Bank of India and its associate banks called the State Bank group b. 20 nationalised banks c. Regional Rural Banks mainly sponsored by Public Sector Banks
PRIVATE SECTOR BANKS a. b. c. d. e.
Old generation private banks New generation private banks Foreign banks in India Scheduled Co-operative Banks Non-scheduled Banks
CO-OPERATIVE SECTOR The co-operative banking sector has been developed in the country to the suppliment the village money lender. The co-operatiev banking sector in India is divided into 4 components 1. 2. 3. 4. 5. 6. 7. 8.
State Co-operative Banks Central Co-operative Banks Primary Agriculture Credit Societies Land Development Banks Urban Co-operative Banks Primary Agricultural Development Banks Primary Land Development Banks State Land Development Banks
DEVELOPMENT BANKS 1. 2. 3. 4. 5. 6. 7. 8. 9.
Industrial Finance Corporation of India (IFCI) Industrial Development Bank of India (IDBI) Industrial Credit and Investment Corporation of India (ICICI) Industrial Investment Bank of India (IIBI) Small Industries Development Bank of India (SIDBI) SCICI Ltd. National Bank for Agriculture and Rural Development (NABARD) Export Import Bank of India National Housing Bank
PUBLIC SECTOR BANKS Before the independence, the banking system in India was primarily associated with urban sector. After independence, the banks had to spread out into rural and unbanked areas and make credit available to the people of those areas. In 1969 the government nationalized 14 major commercial banks. Still the wide disparities continued. To reduce the disparities the government nationalized 6 more commercial banks in 1980 government came to own 28 banks including SBI and its 7 subsidiaries. Today, we are having a fairly well developed banking system with different classes of banks-public sector banks, foreign banks, and private sector banks-both old and new 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. The statistics are as follows: a network of 64000,branches-one branch for every 14000 Indian with over 64 crores customers. This labour intensive network has built-in cost, which makes the public sector banks inherently uncompetitive. Reduction of branches to achieve cost saving has not received a munch thrust as it should. Public sector banks are characterized by mammoth branch network, huge work force, relatively lesser mechanization, and huge volume but of less value business transactions, social objectives and 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 in India have to increase the turnover. Previously, Indian banks were relying on high credit deposit ratio. Now, the Indian banks have to depend on the volume of high business turnover. 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 a crucial 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 the direct results of the expansion of activities of banks. The rapid growth, forever lead to strains in the operational efficiency of the banks and the accumulation of non-performing assets (NPAs) in their loans portfolio. The uncomfortably high level of NPAs of banks however is a cause for worry and it should be brought down to international acceptable levels for creating a vibrant and competitive financial system. NPAs are serious strains on the 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 a reasons for mounting of NPAs priority sector lending, outdated legal system which not only 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. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.
Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas bank Punjab National Bank Punjab and Sind Bank State Bank of India State Bank of India & its associates. 1) State Bank of Hyderabad 2) State Bank of India 3) State Bank of Indore 4) State Bank of Mysore 5) State Bank of Saurashtra 6) State Bank of Travancore
18. Syndicate Bank 19. UCO Bank 20. Union Bank of India (UBI) 21.Vijaya Bank
Deposits Total deposits mobilized by the Public Sector Banks as at the end March 2003 stood at Rs. 10,79,394crore showing a growth of 11.4% which is lower than growth rate of 12.7% recorded at end March 2002. The State Bank of Patiala showed the highest growth in the deposit mobilization with 28.1%, where Orietal Bank of Commerce showed the lowest growth rate of 4.6% at the end March 2003. During the year 2002-2003, 17 Public Sector Banks registered the higher growth than the group average. Investment During 2002-2003, investment rose by Rs. 91,159crore (20%) to Rs. 5, 45,668 crore 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 have registered an impressive growth in investment during 2002-2003 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 2002-2003 due largely to lower economic activity. The total loans and advances position as at end March 2003 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. Vijya Bank tops the position with 27.3% in credit disbursal. Other banks which have showed impressive growth in advances are Canara Bank (22.1%), UCO Bank (24.4%), State Bank of Indore (21.0%),State Bank of Patiala (23.8%)and State Bank of Travancore (23.3%)during 2002-2003. the Bank which registered the lowest growth in credit disbursement was Bank of Baroda with 5.0%.
Table 2: Public Sector Banks: Total Assets, Gross NPA, And Net NPA
Name of the Bank NATIONALI S-ED BANKS Allahabad Bank
Bank of Baroda
Bank of India
Bank of Maharashtra
Central Bank of India
Indian Overseas Bank
Oriental Bank of Commerce
Punjab and Sind Bank
Punjab National Bank
Union Bank of India
United Bank of India
Total of 19 NAT. Bank S
State Bank of India
Associates of SBI State Bank of Bikaner & Jaipur State Bank of Heyderabad
State Bank of Indore
State Bank of Mysore
State Bank of Patiala
State Bank of Saurashtra
State Bank of Travancore
Total of 7 Associates
Total of State Bank Group
Total of Public Sector Bank S
Total Assets Total Assets of the Public Sector Banks increased to Rs.1,28,5236crore as on March 2003 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 Public Sector Banks registered higher than the average rate of growth recorded by the Public Sector Banks as a group. During the previous year (2001-2202), 16 Public Sector Banks registered growth rate higher than the average growth recorded by this group. Non performing Assets Both gross NPA and net NPA at the end March 2003 were lower than the previous year. The gross NPA of Public Sector Banks decreased to Rs. 54,087crore at the end March 2003 from Rs. 56,476crore at end March 2002. Similarly the Net NPA declined from R.s 27,973 crore at the end March 2002 to Rs. 24,963crore at the end March 2003. so far as the growth is concerned, the gross NPA registered (-)4.2%at the end March 2003 as compared to 3.3% of the previous year. In the case of net NPA, it has shown 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 2003.
Table 3: Public Sectors Banks: Profits
Name of the Bank NATIONALIS ED BANKS Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab and Sind Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank Total of 19 NAT. Bank S State Bank of India Associates of SBI State Bank of Bikaner &
Gross profit 2002 2003
Provisions &contingency 2001 2002 2003
Net profit 2002
248.72 1036.47 772.02 239.98
425.38 1309.26 1408.45 415.05
754.83 1716.62 2030.00 520.58
127.5 761.8 520.1 194.7
223.1 763.3 903.2 269.6
351.84 943.84 1179.00 298.56
121.19 274.66 251.88 45.19
202.27 545.93 505.22 145.41
402.9 772.7 851.0 222.0
76.83 61.59 306.60
335.39 307.15 616.36
493.83 590.25 794.14
342.9 335.5 190.6
324.0 273.9 386.1
379.14 401.42 378.04
-266.12 -274.00 115.93
11.36 33.22 230.21
114.1 188.8 419.1
297.79 213.70 511.25
355.24 475.98 869.24
618.79 624.04 1303.92
62.86 180.7 355.7
104.6 311.4 555.1
274.66 416.55 751.23
234.94 33.00 155.47
250.55 164.52 314.13
344.1 207.4 552.6
Jaipur State Bank of Heyderabad State Bank of Indore State Bank of Mysore State Bank of Patiala State Bank of Saurashtra State Bank of Travancore Total of 7 Associates Total of State Bank Group Total of Public Sector Bank S
Profit The total gross profit of the Public Sector Banks stood at Rs.29,715 crore during 2002-03 as compared to Rs. 21,673crore 2001-02. The net profit of the banks also went up from Rs.8,301crore in 2001-02 to R.s12,295crore during 2002-03. highest growth rate in 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 remarkable growth 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 average during 2002-03.
Operating Expenses The operating expenditure as percentage to total expenses moved up from 24.3% in 2001-02 to 24.8% in 2002-03. Oriental Bank of Commerce recorded the least ratio with 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 2002-03 from Rs. 1,08,948crore during 2001-02 showing a growth of 6.6% which is lower than the previous year’s growth of 9.9%. this moderate reduction in the rate of growth in the total expenditure, which recorded a lower growth of 1.0% during 2002-03 as compared to 12.1% 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 2002-03 recorded a growth of 9.4% as compared to the previous year’s declined growth of ()5.6%. 13 Public Sector Banks registered higher growth than the group’s average growth in operating expenses during 2002-03. Highest growth in the operating expenses was recorded by Andhra Bank (32.5%), closely followed by Vijaya Bank (32.1%). The United Bank of India was the only bank with lower operating expenses during 2002-03 as compared to the previous year.
Income Total income of Public Sector Banks, though increased to Rs. 1,28,464crore during the year 2002-03 from Rs. 1,17,252crore during 2001-02, recorded lower growth than the previous year. Growth of income during 2002-03 was 9.6% which is lower than 13.3% of the previous year. Both of the major components of the income, i.e, interest income and other income, registered lower growth than the previous year. Interest income during 2002-03 was Rs.1,00,711crore (10.5%) of the previous year. Similarly, the other income moved up to Rs.21,272crore (28.6%) during 2002-03 as compared to Rs. 16,541crore (33.7%) of the previous year. There is not much variation in the trend in the income pattern of the 19 nationalised banks and SBI groups during the year 2002-03. though the interest income still remain the major contributor to the total income of the group, 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% and further to 16.4% during the year 2000-01, 2001-02, and 2002-03, respectively. The impressive growth in the other income is largely due to the impressive growth in the treasury income of the banks. Conclusion The performance of the Public Sector Banks indicates that their financial position has improved significantly during 2002-03. They made impressive performance in investment and moderate in advances. NPAs of the banks had declined during the year. The rate of growth in the total income of the banks was lower than the previous year. However, other income of the banks, led by treasury income, had steadily increased its share in total income. Total expenditure also recorded a decelerated growth rate during 2002-03 as compared to the previous year .Return on assts of the banks recorded improvement. Profitability of the banks improved considerably during the year.
NON-PERFORMING ASSETS The world is going faster in terms of services and physical products. However it has 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 the economy. 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 plays larger role in channelising money from one end to other end. It helps almost every person in utilizing the money at their best. The banking sector accepts the deposits of the people and 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 the deposits from the people and secondly they lend this money to people who are in the need of 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 Non Performing Assets. This problem has been emerged largely in Indian banking sector since three decade. Due to this problem many Public Sector Banks have been adversely affected 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 clients or 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 healthy financial 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 way that would not destroy the operational, financial conditions and would not affect the image 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 with effect 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 become non-performing, then the bank will have to treat all the advances/credit facilities granted to that borrower as non-performing without having any regard to the fact that there may still 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 secured asset 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 substandard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by RBI. 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. Due to the improvement in the payment and settlement systems, recovery climate, upgradation of technology in the banking system, etc., it was decided to dispense with 'past due' concept, with effect from March 31, 2001. Accordingly, as from that date, a Non performing asset (NPA) shell be an advance 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, in respect 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 harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, and Any amount to be received remains overdue for a period of more than 180 days 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,
The account remains 'out of order' for a period of more than 90 days, in respect of an overdraft/ cash Credit (OD/CC), The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, and Any amount to be received remains overdue for a period of more than 90 days 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 the end of the financial year. Non-Performing Assets: Any loan repayment, which is overdue beyond 180 days or two quarters, is considered as NPA. According to the securitisation and reconstruction of financial assets and 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 the directions or guidelines relating to asset classifications issued by the Reserve Bank” Internationally, 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 been decided to adopt similar practice in our country also. Banks have been advised that they should not charge and take to income account the interest on all Non-performing 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
Nature of Credit Facility
Cash Credit & Overdrafts
Basis for Treating as NPA A term loan is to be treated as NPA if interest remains past due for a period of 4 quarters for the year ended 31-3-1993,3 quarters for the year ended 31-3-1994 and 2 quarters for the year ended 31-3-1995 and onwards. Past due means an amount reaming out standing or unpaid for 30 days beyond due date. For e.g., interest due on 31-3-1993 becomes past due on 30-4-1993, if it is not received by that date. A cash credit or overdraft account should be treated as NPA if the account remains out of order for a period of four quarters during the year ended 31-3-1993,three quarters during the year ended 31-3-1994 and two quarters during the year ended 313-1995 and onwards. An account may be treated as out of order if any of the following three conditions is met The balance outstanding in the account remains continuously in excess of the sanctioned limit or drawing power. OR The balance outstanding is within the limit/drawing power, but there are no credits 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 credits are not enough to cover the interest debited to the account during the same period. III.
Bill Purchased and Discounted
An account should be treated as NPA if the bill remains overdue and unpaid for a period of four quarters during the year ended 31st March, 1994 and two quarters during the year ended 31st March, 1995 and onwards. It may be added that overdue interest should not be charged and taken to income account in respect of overdue bills unless it is realized.
Any other credit facility should be treated as NPA if any amount to be received in respect of that facility remains past due for a period of four quarters during the year ended 31st March 1993. There quarters during the year ended 31st March 1994 and two quarters during the year ended 31st March 1995 and onwards.
Category of assets
Basis for Deciding the category
I. Standard Assets An asset, which does not disclose any problem and also does not carry more than normal risk attached to the business, it should not fall under this category of NPA. II. Sub-Standard Assets An asset, which has been identified as NPA for 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 be treated as sub-standard asset. An asset where the terms of the loan agreement regarding interest and principal have been re-negotiated or re-scheduled should be classified as sub-standard and should remain in such category for at least two years of satisfactory performance under the re-negotiated or rescheduled terms. In other words, the classification of assets should not be upgraded merely as a result of re-scheduling unless there is satisfactory compliance of the above condition. III. Doubtful Assets
An asset, which remains NPA for more than two years. Here too, rescheduling does not entitle a bank to upgrade the quality of an advance automatically.
In the case of a term loan, if installments of principal are overdue for more than two years, it is to be treated as doubtful. IV. Loss Assets An asset where loss has been identified by the bank or internal/external auditors or by RBI inspection but the amount has not been written-off, wholly or partly. In other words, such an asset is considered unrealizable and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.
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 Indian economy 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's credit 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. 1,10,000 crores. Bankers have realized that unless the level of NPAs is reduced drastically, they will find it difficult to survive. The actual level of Non Performing Assets in India is around $40 billion much higher than government’s estimation of $16 billion. This difference is largely due to the discrepancy in accounting the NPAs followed by India and rest of the world. The Accounting 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 many Asian 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 2000 to $2 billion in 2002.looking to such overall picture of the market, we can say that India is 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 financial sector in India for the year ended March 31, 2003, approximately Rs. 452 billion from the total gross NPAs of Indian banking sectors • Public Sector Banks cover 55% of gross NPAs • Private sector banks cover 11% of gross 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, and other activities such as small business, retail trade, small transport operators, professional and self employed persons, housing, education loans, micro-credit etc. In addition, certain investments in bonds issued by State Financial Corporations (SFCs), State Industrial Development 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 priority sector including agriculture, small scale and others. The balance 77% belongs to NPAs in the 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 proportion among the corporate borrowers is private sector corporate borrowers. Since the sectoral segmentation norms are applicable to banks only the above graph 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 proportion of NPAs.
Sectoral Segmentation 0% 2%
47% 14% 5% Agriculture Retail Borrower Corporate Borrower
other Small Scale Industry
Joint sector State Owned Co
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 the large 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 alone comprise 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 the gross 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 in the top 5 industries viz. textiles, iron & steel, chemicals, engineering and metals. Only about 20% of the Large NPA portfolio by gross value is in sub-standard assets. This indicates that the rehabilitation potential of, about 80% of the Large NPA portfolio in each of the top 5 industries is somewhat limited.
Nearly 68% of the gross NPAs by gross value are in the doubtful category. Within this, 28% by gross value are in the C3 subcategory. It might be worth noting that C3 category comprises assets that have been non-performing for at least 5 years and that there 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 in each of the top industries (other than Chemicals) are loss assets.
Industry Classification 15% 14%
5% Textiles Engineering
Iron & Steel Metals
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 the lenders included in this study are Maharashtra (including Goa), Gujarat, Delhi (including Rajasthan), Andhra Pradesh and Tamil Nadu. The Large NPAs in these 5 states alone comprise approximately 65% of the total Large NPA portfolio (by gross value) of the lenders in the sample. Maharashtra (including Goa) with nearly 24% is the single largest contributor to the 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% and Tamil Nadu with just under 10%.
State Wise Distribution 24%
10% Maharashtra Andhra Pradesh
Gujarat Tamil Nadu
11% 10% Delhi, Rajesthan Other
5. Region-wise Distribution The NPA portfolios of lenders covered in the study have been segmented into the following 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 with 24% each. Eastern and Central regions have a lower proportion of NPAs by gross value at 10% and 6% respectively. On an overall basis, the geographical distribution of NPAs is clearly linked to the level of industrialization in various parts of India. The Western region in general and Maharashtra 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.
Regional Distribution 6%
36% 10% 24% Northern
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/nonoperating 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 a very small proportion of the Large NPA portfolio (by gross value) is under implementation. The remaining is more or less equally split between assets which are operating and those which are not.
7. Security Profile The data on break-up of the number and gross value of the Large NPAs based on the type of security (Fixed assets/current assets) was also received from the participant lenders. It can be seen from the Chart below that 89% of the secured large NPAs are secured 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 India and 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 (both gross and net) have been declining over the last few years. In fact in the year ended March 31, 2003, the levels of NPAs have also declined in absolute terms also as compared to the previous year. The Indian system is moving towards international practices which utilize significant qualitative measures in addition to quantitative measures. Such a change may contribute to standard loans being graded as NPAs in the future. Also, according to some estimates, the application of the 90 days past due criteria from March 31, 2004 (as proposed by RBI) will increase gross NPAs by 3-5% of gross advances.
UNDERLYING REASONS FOR NPAS IN INDIA An internal study conducted by RBI shows that in the order of prominence, the following factors contribute to NPAs. Internal Factors •
Diversion of funds for o Expansion/diversification/modernization o Taking up new projects o Helping/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 •
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 were reaffirmed, 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 competitive market 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 monitoring of sometimes-complex credit files has not received the attention it needed, which meant that early warning signals were not recognised and standard assets slipped to NPA category without banks being able to take proactive measures to prevent this. Partly due to this reason, adverse trends in borrowers' performance were not noted and the position further deteriorated before action was taken. •
Over optimistic promoters Promoters were often optimistic in setting up large projects and in some cases were not fully above board in their intentions. Screening procedures did not always highlight these issues. Often projects were set up with the expectation that part of the funding 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 funds could never be raised, promoters often lost interest and lenders were left stranded with incomplete/unviable projects. •
Directed lending Loans to some segments were dictated by Government's policies rather than commercial imperatives. •
Highly leveraged borrowers Some borrowers were under capitalized and over burdened with debt to absorb the changing economic situation in the country. Operating within a protected market resulted in low appreciation of commercial/market risk. •
Funding mismatch There are said to be many cases where loans granted for short terms were used to fund long term transactions. • High Cost of Funds Interest rates as high as 20% were not uncommon. Coupled with high leveraging and falling demand, borrowers could not continue to service high cost debt. •
Willful Defaulters There are a number of borrowers who have strategically defaulted on their debt service obligations realizing that the legal recourse available to creditors is slow in achieving results
EXISTING SYSTEMS/PROCEDURES FOR NPA IDENTIFICATION 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 adopted an 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 reviewing their exposure to borrower accounts every quarter based on published data which also serves 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 Financial Supervision are as follows: i) Designating Relationship Manager/ Credit Officer for monitoring account/s ii) Preparation of `know your client' profile iii) Credit rating system iv) Identification of watch-list/special mention category accounts v) Monitoring of early warning signals
Relationship Manager/Credit Officer The Relationship Manager/Credit Officer is an official who is expected to have complete knowledge of borrower, his business, his future plans, etc. The Relationship Manager has to keep in constant touch with the borrower and report all developments impacting the borrowal account. As a part of this contact he is also expected to conduct scrutiny 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 credit exposure 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 most of the banks have developed their own models, a few banks have adopted credit rating models designed by rating agencies. Credit rating models take into account various types of risks viz. financial, industry and management, etc. associated with a borrowal unit. The exercise is generally done at the time of sanction of new borrowal account and at the time of review / renewal of existing credit facilities. •
Watch-list/Special Mention Category The grading of the bank's risk assets is an important internal control tool. It serves the need of the Management to identify and monitor potential risks of a loan asset. The purpose of identification of potential NPAs is to ensure that appropriate preventive / corrective steps could be initiated by the bank to protect against the loan asset becoming non-performing. Most of the banks have a system to put certain borrowal accounts under watch list or special mention category if performing advances operating under adverse business or economic conditions are exhibiting certain distress signals. These accounts generally exhibit weaknesses which are correctable but warrant banks' closer attention. The categorisation of such accounts in watch list or special mention category provides
early warning signals enabling Relationship Manager or Credit Officer to anticipate credit deterioration and take necessary preventive steps to avoid their slippage into non performing advances. •
Early Warning Signals It is important in any early warning system, to be sensitive to signals of credit deterioration. A host of early warning signals are used by different banks for identification of potential NPAs. Most banks in India have laid down a series of operational, financial, transactional indicators that could serve to identify emerging problems in credit exposures at an early stage. Further, it is revealed that the indicators which may trigger early warning system depend not only on default in payment of installment and interest but also other factors such as deterioration in operating and financial performance of the borrower, weakening industry characteristics, regulatory changes, general economic conditions, etc. Early warning signals can be classified into five broad categories viz. (a) financial (b) operational (c) banking (d) management and (e) external factors. Financial related warning signals generally emanate from the borrowers' balance sheet, income expenditure statement, statement of cash flows, statement of receivables etc. Following common warning signals are captured by some of the banks having relatively developed EWS. Financial warning signals • • • • • • • • • • • • • •
Persistent irregularity in the account Default in repayment obligation Devolvement of LC/invocation of guarantees Deterioration in liquidity/working capital position Substantial increase in long term debts in relation to equity Declining sales Operating losses/net losses Rising sales and falling profits Disproportionate increase in overheads relative to sales Rising level of bad debt losses Operational warning signals Low activity level in plant Disorderly diversification/frequent changes in plan Nonpayment of wages/power bills Loss of critical customer/s
Frequent labor problems Evidence of aged inventory/large level of inventory
Management related warning signals • • • • • • •
Lack of co-operation from key personnel Change in management, ownership, or key personnel Desire to take undue risks Family disputes Poor financial controls Fudging of financial statements Diversion of funds
Banking related signals • • • • • •
Declining bank balances/declining operations in the account Opening of account with other bank Return of outward bills/dishonored cheques Sales transactions not routed through the account Frequent requests for loan Frequent delays in submitting stock statements, financial data, etc.
Signals relating to external factors • • • • •
Economic recession Emergence of new competition Emergence of new technology Changes in government / regulatory policies Natural calamities
2. Management/Resolution of NPAs A reduction in the total gross and net NPAs in the Indian financial system indicates a significant improvement in management of NPAs. This is also on account of various resolution mechanisms introduced in the recent past which include the SRFAESI Act, 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, 2003, there were 1,522 numbers of NPAs as on March 31, 2003 which had gross value greater than Rs. 50 million in all the public sector banks in India. The total gross value of these NPAs amounted to Rs. 215 billion. The total number of resolution approaches (including cases where action is to be initiated) 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 NPAs in 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 that Compromise settlement schemes with borrowers are found to be more effective than legal measures. Many banks have come out with their own restructuring schemes for settlement of NPA accounts. 3. Credit Information Bureau State Bank of India, HDFC Limited, M/s. Dun and Bradstreet Information Services (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 credit Information 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 to submit the list of suit-filed cases of Rs. 10 million and above and suitfiled cases of willful defaulters of Rs. 2.5 million and above to RBI as well as CIBIL. CIBIL will share this information with commercial banks and FIs so as to help them minimize adverse selection at appraisal stage. The CIBIL is in the process of getting operationalised. 4. Willful Defaulters RBI has issued revised guidelines in respect of detection of willful default and diversion 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 which finance was granted. The list of willful defaulters is required to be submitted to SEBI and RBI 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 unscrupulous elements. RBI has advised lenders to initiate legal measures including criminal actions,
wherever required, and undertake a proactive approach in change in management, where appropriate. 5. Legal and Regulatory Regime A. Debt Recovery Tribunals DRTs were set up under the Recovery of Debts due to Banks and Financial Institutions Act, 1993. Under the Act, two types of Tribunals were set up i.e. Debt Recovery Tribunal (DRT) and Debt Recovery Appellate Tribunal (DRAT). The DRTs are 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 the Appellate Tribunal but no appeal shall be entertained by the DRAT unless the applicant deposits 75% of the amount due from him as determined by it. However, the Affiliate Tribunal may, for reasons to be received in writing, waive or reduce the amount of such deposit. 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 from transferring, alienating or otherwise dealing with or disposing of any property and the assets belonging to him within prior permission of the Tribunal. This order can be passed even while the claim is pending. DRTs are criticised in respect of recovery made considering the size of NPAs in the Country. In general, it is observed that the defendants approach the High Country challenging the verdict of the Appellate Tribunal which leads to further delays in recovery. Validity of the Act is often challenged in the court which hinders the progress of the DRTs. Lastly, many needs to be done for making the DRTs stronger 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. Cases involving suit claims upto Rs. l million can be brought before the Lokadalat and every award of the Lokadalat shall be deemed to be a decree of a Civil Court and no appeal can lie to any court against the award made by the Lokadalat.
Several people of particular localities/ various social organisations are approaching Lokadalats which are generally presided over by two or three senior persons including retired senior civil servants, defense personnel and judicial officers. They take up cases which are suitable for settlement of debt for certain consideration. Parties are heard and they explain their legal position. They are advised to reach to some settlement due to social pressure of senior bureaucrats or judicial officers or social workers. If the compromise 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 will have a right to get the decree from the court. In general, it is observed that banks do not get the full advantage of the Lokadalats. 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 Enforcement of Security Interest Act" (SRFAESI) provides the formal legal basis and regulatory framework for setting up Asset Reconstruction Companies (ARCs) in India. In addition to 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 reconstruction transactions as well as any creation of security interests has to be filed.
The Reserve Bank of India (RBI), the designated regulatory authority for ARCS has issued Directions, Guidance Notes, Application Form and Guidelines to Banks in April 2003 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 banks and financial institutions on issues relating to transfer of assets to ARCS, consideration for the same and valuation of instruments issued by the ARCS. Additionally, the Central Government has issued the security enforcement rules ("Enforcement Rules"), which lays down the procedure to be followed by a secured creditor while enforcing its security interest pursuant to the Act.
The Act permits the secured creditors (if 75% of the secured creditors agree) to enforce their security interest in relation to the underlying security without reference to the 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 the secured creditors to take any of the following measures: • Take over possession of the secured assets of the borrower including right to transfer by way of lease, assignment or sale; • Take over the management of the secured assets including the right to transfer 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 which has been transferred. After taking over possession of the secured assets, the secured creditors are required to obtain valuation of the assets. These secured assets may be sold by using any of the following routes to obtain maximum value. • By obtaining quotations from persons dealing in such assets or otherwise interested in buying the assets; • By inviting tenders from the public; • By holding public auctions; or • By private treaty. 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 are now clearly in a much better bargaining position vis-a-vis defaulting borrowers than they were 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 a large number of NPAs being resolved in quick time, either through security enforcement or 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 and SRFAESI 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, on an 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 from the date of acquisition of the assets. The Act stipulates several measures that can be undertaken by ARCs for asset reconstruction. These include: a) Enforcement of security interest; b) Taking over or changing the management of the business of the borrower; c) The sale or lease of the business of the borrower; d) Settlement of the borrowers' dues; and e) Restructuring or rescheduling of debt. ARCS are also permitted to act as a manager of collateral assets taken over by the lenders 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. They can 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 mechanism instituted 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 and transparent restructuring of corporate debt outside the purview of the Board for Industrial and Financial Reconstruction (BIFR), DRTs or other legal proceedings. The framework is intended to preserve viable corporates affected by certain internal/external factors and minimise losses to creditors/other stakeholders through an orderly and coordinated restructuring programme. RBI has issued revised guidelines in February 2003 with respect to the CDR mechanism. Corporate borrowers with borrowings from the banking system of Rs. 20 crores and above under multiple banking arrangement are eligible under the CDR mechanism. Accounts falling under standard, sub-standard or doubtful categories can be considered 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 a restructuring plan on the lines of the expected business plan alongwith projected cash flows. The CDR process is being stabilized. Certain revisions are envisaged with respect to 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 signing the agreements shortly. However they attend meetings. The first ARC to be operational in India- 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 in multiple lender arrangements and to increase transparency in the process. While in the RBI guidelines it has been recommended to involve independent consultants, banks are so far resorting to their internal teams for recommending restructuring programs. As of March 31, 2003, 60 cases worth Rs. 44,369 crores had been referred to the CDR, 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. The scheme also covers NPAs classified as sub-standard as on 31st March 2000, which have subsequently become doubtful or loss. All cases on which the banks have initiated action under the SRFAESI Act and also cases pending before Courts/DRTs/BIFR, subject to consent decree being obtained from the Courts/DRTs/BIFR are covered. However cases of willful default, fraud and malfeasance are not covered. As per the OTS scheme, for NPAs upto Rs. 10 crores, the minimum amount that should be recovered should be 100% of the outstanding balance in the account. For NPAs above Rs. 10 crores the CMDs of the respective banks should personally supervise the settlement of NPAs on a case to case basis, and the Board of Directors may evolve policy guidelines regarding one time settlement of NPAs as a part of their loan recovery policy. As on March 31, 2003 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 recoveries affected were for 30,888 cases amounting to Rs. 168 crores. For OTS under banks' own scheme the corresponding recoveries were for 1.62 lakh accounts amounting to Rs. 1,583 crores. •
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 broad framework for such settlements was put in place in July 1995. Specific guidelines were issued in May 1999 to public sector banks for one-time settlements of NPAs of small scale 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 June 2001 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 an enquiry is pending as to whether it should be admitted to BIFR), it is afforded protection against 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 to file a reference in BIFR so as to obtain protection from debt recovery proceedings. The recent amendments to the Companies Act vest powers for revival and rehabilitation of companies with the National Company Law Tribunal (NCLT), in place of BIFR, with modifications to address weaknesses experienced under the SICA provisions. The NCLT would prepare a scheme for reconstruction of any sick company and there is no bar on the lending institution of legal proceedings against such company whilst the scheme is being prepared by the NCLT. Therefore, proceedings initiated by any creditor seeking to recover monies from a sick company would not be suspended by a reference to the NCLT and, therefore, the above provision of the Act may not have much 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 Head Offices for dealing with NPAs. The participants were generally of the view that though time and resources were adequate for dealing with NPAs, skills needed to be improved upon. Within the constraints of the existing legal and regulatory environment banks in India 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 early recognition and faster provisioning of NPAs, banks now need to evolve systems that help them identify potential NPAs and take quick action to: • Prevent the potential NPA from actually becoming non-performing, and • Avoid increasing their exposure to such potential NPAs.
INTERNATIONAL PRACTICES ON NPA MANAGEMENT Subsequent to the Asian currency crisis which severely crippled the financial system in most In addition to the above, some of the more recent and aggressive steps to resolve NPAs have been taken by Taiwan. Taiwanese financial institutions have been encouraged to merge (though with limited success) and form bank based AMCs through the recent introduction of Financial Holding Company Act and Financial Institution Asian countries, the magnitude of NPAs in Asian financial institutions was brought to light. Driven by the need to proactively tackle the soaring NPA levels the respective Governments embarked upon a program of substantial reform. This involved setting up processes for early identification and resolution of NPAs. The table 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 2003), while also providing flexibility in modes of NPA asset resolution and a conducive regulatory and tax 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 comment on'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 in South East Asian countries. 1. Credit Risk Mitigation As part of the overall credit function of the bank, early recognition of loans showing signs of distress is a key component. Credit risk management focuses on assessing credit risk and matching it with capital or provisions to cover expected losses from default. 2. Early Warning Systems Loan monitoring is a continuous process and Early Warning Systems are in place for staff to continuously be alert for warning signs.
3. Asset Management Companies To resolve NPA problems and help restore the health and confidence of the financial 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, often working along with independent advisors. This broad approach was locally adapted and used with a varying degree of efficacy across the region. For example, while in some countries a centralised government sponsored AMC model has been used, in others a more decentralized approach has been used involving the creation of several "bankbased" AMCs. Further different countries have allowed/used different approaches (inhouse restructuring versus NPA Sale) to resolve their NPAs. Additionally, the efficacy of bankruptcy and foreclosure laws has varied in various countries. A number of factors influenced the successful resolution of NPAs through sale to AMCs and some of these key factors are discussed below •
Increasing willingness to sell NPAs to AMCs Bottlenecks often persist on account of reluctance of lenders to transfer assets to the AMCs at values lower than the book value to prevent a hit to their financials. Banks in 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 the Central Bank to make adjustments in the book values of the assets not transferred to Danaharta (after Danaharta identifies them) were sufficient to ensure effective sale to the AMC. In Taiwan, there is a regulatory requirement to reduce for banks to reduce NPAs to 5% by the end of 2003. Consequently there is an increasing number of NPA auctions by the banks. •
Effective resolution strategy A significant dimension influencing NPA resolution and investor participation is the 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 down creditor's rights. Danaharta has been allowed to foreclose property without reference to the 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 have also 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 the restructuring 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 process affected by the automatic moratorium that comes into place at the time of the administrator’s appointment. 4. out of court restructuring Most Asian countries adopted “out of court” restructuring mechanism to minimize court intervention and speed up restructuring of potentially viable entities. Internationally, restructuring of NPAs often involves significant operational restructuring in addition to financial restructuring. The operational restructuring measures typically include the following areas: •
Working capital management
Sale of redundant/surplus assts Once the restructuring measures have been agreed by stakeholders, a complete restructuring plan is prepared which takes into account all the agreed restructuring measures. This includes establishment of a timetable and assignment of responsibilities. Usually, lenders will also establish a protocol for monitoring of progress on the operational restructuring measures. This would typically involve the appointment of an independent monitoring agency. As seen from the Asian experience, in general, NPA resolution has been most successful 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.
RATIO ANALYSIS The relationship between two related items of financial statements is known as ratio. A ratio is just one number expressed in terms of another. The Ratio is customarily expressed in three different ways. It may be expressed as a proportion between the two figures. Second it may be expressed in terms of percentage. Third, it may be expressed in terms of rates. The use of ratio has become increasingly popular during the last few years only. Originally, the bankers used the current ratio to judge the capacity of the borrowing business enterprises to repay the loan and make regular interest payments. Today it has assumed to be important tool that anybody connected with the business turns to ratio for measuring the financial strength and the earning capacity of the business.
1. GROSS NPA RATIO: Gross NPA Ratio is the ratio of gross NPA to gross advances of the Bank. Gross NPA is the sum of all loan assets that are classified as NPA as per the RBI guidelines. The ratio is to be counted in terms of percentage and the formula for GNPA is as follows: Gross NPA ratio =
Gross NPA *100 Gross advances
Name of Bank
NATIONALISED BANKS Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab and Sind Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Gross NPA to Gross advances 2001 2002 2003 4 5
17.66 6.13 14.11 10.25 12.35
16.94 5.26 12.39 9.37 10.44
13.65 4.89 11.02 8.55 9.55
5.40 25.34 21.76 11.81
5.19 24.11 17.86 11.35
5.27 17.86 12.39 10.29
7.87 11.64 11.20 21.54
8.35 9.59 10.77 16.36
8.32 8.24 8.96 12.15
2 3 1 2 3 4 5 6 7
Total of 19 NAT. Bank S State Bank of India Associates of SBI
State Bank of Bikaner & Jaipur State Bank of Heyderabad State Bank of Indore State Bank of Mysore State Bank of Patiala State Bank of Saurashtra State Bank of Travancore
Total of 7 Associates Total of State Bank Group Total of Public Sector Bank S
The table above indicates the quality of credit portfolio of the banks. High gross NPA ratio indicates the low credit portfolio of bank and vice-a-versa. We can see from the above table that the Punjab and Sind Bank has the higher gross NPA ratio of 19.25 % followed by the Dena Bank with 17.86 %. The Allahabad Bank, Central Bank of India and united Bank of India also have higher gross NPA ratio with 13.65 %, 13.06% and 12.15%. Whereas the state Bank of Patiala, Andhra Bank and Canara Bank showed lower ratio with 4.8 %, 4.89 % and 5.96 % in the year 2003.
2. NET NPA RATIO The net NPA percentage is the ratio of net NPA to net advances, in which the provision is to be deducted from the gross advance. The provision is to be made for NPA account. The formula for that is: Net NPA Ratio =
Gross NPA-Provision * 100 Gross Advances-Provisions
Name of Bank
NATIONALISED BANKS Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab and Sind Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Total of 19 NAT.
Net NPA to Net Advances 2001 2002 2003 3 4 5
11.23 2.95 6.77 6.72 7.41
11.09 2.45 4.98 6.02 5.81
7.08 1.79 3.72 5.59 4.82
1.98 18.37 10.06 7.01
2.31 16.31 8.28 6.32
1.65 11.83 6.15 5.23
4.05 6.35 6.87
4.63 5.45 6.26
4.29 4.36 4.91
2 3 1 2 3 4 5 6 7
Bank S State Bank of India Associates of SBI
State Bank of Bikaner & Jaipur State Bank of Heyderabad State Bank of Indore State Bank of Mysore State Bank of Patiala State Bank of Saurashtra State Bank of Travancore
Total of 7 Associates Total of State Bank Group Total of Public Sector Bank S
This ratio indicates the degree of risk in the portfolio of the banks. High NPA ratio indicates the high quantity of risky assets in the Banks for which no provision are made. From the table it becomes clear that the NPA ratio of almost all the Banks have been improved quite well as compared to the previous year. The Dena bank has the highest NPA ratio of 11.83 % followed by the Punjab and the Sind Bank with 10.89 %. The Oriental Bank of Commerce has showed the lowest NPA ratio 1.4 % and State Bank of Patiala, Andhra Bank have also showed lower NPA ratio with 1.49 % and 1.79 % in 2003.
3. PROVISION RATIO Provisions are to be made for to keep safety against the NPA, & it directly affect on the gross profit of the Banks. The provision Ratio is nothing but total provision held for NPA to gross NPA of the Banks. The formula for that is, Provision Ratio=
Total Provision *100 Gross NPAs
Name of Bank
NATIONALISED BANKS Allahabad Bank
Bank of Baroda
4 5 6 7
Provision Ratio 2002 2003 4 5
Bank of India
12.41359 27.12827 18.20021 15.14677
16.37335 42.56687 17.00332 24.26733
51.57969 60.58894 22.64546 30.99369
Bank of Maharashtra Canara Bank
13.03443 55.74535 17.78598 14.22552
16.02666 59.73437 16.23381 12.59246
19.06073 66.40856 23.45322 24.62971
22.01548 8.05847 23.37148 45.66927
29.61992 19.33994 30.48321 31.46368
Central Bank of India Corporation Bank
Indian Overseas Bank Oriental Bank of Commerce Punjab and Sind Bank Punjab National Bank Syndicate Bank
Union Bank of India
13.91781 5.849618 14.07922 17.3017
United Bank of India
12 13 14
Total of 19 NAT. Bank S State Bank of India
Associates of SBI
State Bank of Bikaner & Jaipur State Bank of Heyderabad State Bank of Indore
2 3 4 5 6 7
State Bank of Mysore State Bank of Patiala State Bank of Saurashtra State Bank of Travancore Total of 7 Associates Total of State Bank Group Total of Public Sector Bank S
This Ratio indicates the degree of safety measures adopted by the Banks. It has direct bearing on the profitability, Dividend and safety of shareholders’ fund. If the provision ratio is less, it indicates that the Banks has made under provision. The highest provision ratio is showed by corporation Bank with 66.40 % followed by Oriental Bank of commerce with 61.60 %. The lowest provision ratio is showed state Bank of Patiala with only 10.97 % in the year 2003.
4. Problem asset ratio It is the ratio of gross NPA to total asset of the bank. The formula for that is:
Problem Asset Ratio =
GrossNPAs TotalAsset s
Name of the Bank
1 1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
2 1 2 3 4
Proble asset ratio 2001 2002 2003 3 4 5
NATIONALISED BANKS Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab and Sind Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank Total of 19 NAT. Bank S State Bank of India State Bank of Bikaner & Jaipur State Bank of Heyderabad State Bank of Indore State Bank of Mysore 104
5 6 7
State Bank of Patiala State Bank of Saurashtra State Bank of Travancore Total of 7 Associates Total of State Bank Group Total of Public Sector Bank S
It has been direct bearing on return on assets as well as liquidity risk management of the bank. High problem asset ratio, which means high liquid. from the above table it becomes clear that Punjab and Sind Bank and Dena Bank have the high ratio of 8.6% and 8.0%.thts ratio implies that the both above banks have the liquid assets through which they will be able torepay their liabilities of deposits quickly as compared to other banks.
5. Capital Adequacy Ratio Capital Adequacy Ratio can be defined as ratio of the capital of the Bank, to its assets, which are weighted/adjusted according to risk attached to them i.e. Capital Adequacy Ratio =
Risk Weighted Assets
As per prudential Norms Banks were required to achieve 8% CAR, increased to 9% by March 2000. For the purpose of capital Adequacy Achievement, the capital base i.e. Tire I + Tire II should not be less than the prescribed % of total Risk Weighted Assets of the bank. S.No.
Name of the Bank
Capital adequacy ratio 2002 2003 4 5
1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
NATIONALISED BANKS Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank of India Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank of Commerce Punjab and Sind Bank Punjab National Bank Syndicate Bank UCO Bank Union Bank of India United Bank of India Vijaya Bank
10.5 13.4 12.8 12.23 10.64 9.84 10.02 13.03 7.73 -12.77 10.24 11.81 11.42 10.24 11.72 9.05 10.86 10.40 11.50
10.62 12.59 11.32 10.68 11.16 11.88 9.58 17.90 7.64 1.70 10.82 10.99 10.70 10.70 12.12 9.64 11.07 12.02 12.25
11.15 13.62 12.65 12.02 11.76 12.50 10.51 18.50 9.33 10.85 11.30 14.04 10.43 12.02 11.03 10.04 12.41 15.17 12.66
2 3 1 2 3
Total of 19 NAT. Bank S State Bank of India Associates of SBI State Bank of Bikaner & Jaipur State Bank of Heyderabad State Bank of Indore
12.39 12.28 12.73
12.26 13.67 12.78
13.08 14.91 13.09
4 5 6 7
State Bank of Mysore State Bank of Patiala State Bank of Saurashtra State Bank of Travancore
11.16 12.37 13.89 11.79
11.81 12.55 13.20 12.54
11.62 13.57 13.68 11.30
The capital adequacy ratio is important for the to maintain as per the banking regulations. As far as this ratio is concerned the Corporation Bank has shown much appreciated result by acquiring the ratio of 18.50% followed by the United Bank of India and State Bank of Hydrabad having ratios of 15.17%and 14.91%. But one remarkable performance is done by the Indian Bank which had CAR in negative with -12.77% in 2001 but improved its performance in 2003 by acquiring CAR 10.85% Tire-I: Paid up capital, Statutory Reserve, Revenue capital reserves (excluding revolution reserve) and other undisclosed reserves LESS accumulated losses till the current year, investment in subsidiaries, other intangible assets. Tire-II: Property Revaluation discounted by 55%, Subordinate Loans, Privately placed Bonds, Hybrid capital, Investment Fluctuation Reserve, provisions on standard assets. & Capital should not exceed Tire-I
6. SUB-STANDARD ASSETS RATIO It is the ratio of Total Substandard Assets to Gross NPA of the bank. Substandard Assets Ratio=
total substandard assets *100 Gross NPAs
The ratios calculated below are for the entire public sector banks: (Rs. In crore) Year Substandard Assets Gross NPAs
2001 14745 54674.47
2002 15788 56476.13
2003 14909 54087.08
Calculations of ratio 2001 26.96%
It indicates scope of up gradation/improvement in NPA. Higher substandard asset ratio means that in whole NPA the sub standard ratio has major proportion, which indicates that there is a high scope for advance up gradation or improvement because it will be very easy to recover the loan as minimum duration of default. Till 2000 this ratio of PSB was very high but dropped in recent years &than again it increased, which means there is a need of advance up gradation.
7.DOUBTFUL ASSET RATIO: It is the ratio of Total Doubtful Assets to Gross NPAs of the bank. Doubtful Asset Ratio=
Year Doubtful Assets Gross NPAs
total doubtful assets *100 Gross NPAs
2001 33485 54674.47
The ratios calculated below are for the entire public sector banks: 2001 2002 2003 61.24% 59.59% 59.79%
It indicates the scope of compromise for NPA reduction. Above table shows the doubtful asset ratio of PSB, which is quite low in 2000 but has increased in recent years. This means that the bank will have to go through compromise measure for increasingly number of times as its substandard ratio has decreased in recent years.
8.LOSS ASSET RATIO: It is the ratio of total loss assets to Gross NPA of the bank. Loss Asset Ratio=
Year Loss Assets Gross NPAs
Total Loss Assets * 100 Gross NP A 2001
The ratios calculated below are for the entire public sector banks: 2001 2002 2003 11.96% 12.50% 12.65%
It indicates the proportion of bad loans in the bank. Above table shows sLoss Asset Ratio of PSB, which shows that the bank has maintained lower loss asset ratio, which indicate that the bank has lower bad loans. However compared to the ratio of 1999-2000 the same has increased in the recent year, which is detrimental to the bank. The bank must take necessary steps to control this ratio, as it is the indication that there is increasing incidence of erosion of securities and fraudulent Loan Accounts in the bank.
Fish eye view of the ratio analysis Ratios 1. Gross NPA Ratio 2. Net NPA Ratio 3. Provision Ratio 4. Problem Asset Ratio 5. Capital Adequacy Ratio
Classifications of Loan Assets of PSBs:
Doubtful Loss Assets Total NPAs Assets
% Amount % Amount % Amount % Amount
Public Sector Banks 1999 2,73,618 84.1 16,033 4.9 29,252 9.0
6,425 2.0 51,710 15.9 3,25,328
2000 3,26,783 86.0 16,361 4.3 30,535 8.0
6,398 1.7 53,294 14.0 3,80,077
2001 3,87,360 87.6 14,745 3.3 33,485 7.6
6,544 1.5 54,774 12.4 4,42,134
2002 4,52,862 88.9 15,788 3.1 33,658 6.6
7,061 1.4 56,507 11.1 5,09,369
As per the above table, given the maximum advances in 2002 amount which 5,01,369 crore which increase from the 3,25,328. They are trying to reduce the NPA by various means. In 2002 total NPA of PSBs has 11.9% , which is reduce from the 15.9% in 1999 Percentage of standard assets increased from 84.1% to 88.9% during the 1990 to 2002. % of loss assets, decreased from 2.0% to 1.4% during the 1999 to 2002. In future, if it will reduce in this manner then it will reduce up to 0% NPA.
Sector Wise Classification 0f NPA:
(Amount in Rs. crore) Bank Group
Non-priority Public Sector Total Sector Amount Per cent Amount Per cent Amount Per cent Amount
A. State Bank of India and its Associates 1995 1996 1997 1998 1999
6967 7041 7247 7470 8318
52.5 53.7 50.4 48.1 44.6
5496 5263 6291 7390 9668
41.4 40.1 43.8 47.6 51.9
809 816 829 662 655
6.1 6.2 5.8 4.3 3.5
13271 13120 14367 15522 18641
2000 2001 2002
8947 8928 9019
45.2 44.2 45.7
10266 10050 10105
51.9 49.8 51.2
560 1213 619
2.8 6.0 3.1
19773 20191 19744
B. NATIONALIZED BANKS 1995 12242 1996 12065 1997 13527 1998 13714 1999 14288 2000 14768 2001 15228 2002 16121
48.7 45.6 46.3 45.5 43.2 44.1 46.2 43.9
12366 13804 15050 15717 17940 18258 17257 20146
49.2 52.2 51.5 52.2 54.3 54.5 52.3 54.8
507 595 632 700 841 495 498 496
2.0 2.2 2.2 2.3 2.5 1.5 1.5 1.3
25115 26464 29209 30130 33069 33521 32983 36763
C. Public Sector Banks (A+B) 1995 19209 1996 19106 1997 20774 1998 21184 1999 22606 2000 23715 2001 24159 2002 25139
50.0 48.3 47.7 46.4 43.7 44.5 45.4 44.5
17861 19067 21341 23107 27608 28524 27307 30251
46.5 48.2 49.0 50.6 53.4 53.5 51.4 53.5
1316 1411 1461 1362 1496 1055 1711 1116
3.4 3.6 3.4 3.0 2.9 2.0 3.2 2.0
38385 39584 43577 45653 51710 53294 53174 56507
SECTOR-WISE NPA POSITION
2% 45% 53%
Priority Sector Public Sector
The above chart represent the NPA position in different types of sectors like priority, Non priority and public sector. The highest % of NPAs are in the Non-priority sector under which the criteria of to given loans are not to be maintained strictly so far. The NPA % of Non-priority sector is highest with 53% whereas 45% NPAs in priority sector which included agriculture, small-scale industry, small business etc.
The glance of NPAs year by year (Rs. In crore) year 1997 1998 1999 2000 2001 2002 2003
NPAs 47,300 50,815 58,554 60,408 63,883 80246 94905
However the problem of NPAs has made its home since last three and half decade, since then it is found that the NPAs are increasing year by year. If we look to the numbers of the NPAs , we may find that in 1997 the NPAs were at Rs.47,300crore and in 2001 they were at Rs. 63,883, but after this period the NPAs increased in the Indian banking sector very drastically. It reached to Rs.80246crore in 2002 and in 2003 it touched to the Rs. 94,905crore. Recently RBI is taking its measures but but the result is not up to the expectations and no doubt that some of the measures have been wrathful to the banks, what I think is that those steps should be taken out that would help the banks to reduce the problem of increasing NPAs. The Banks should also be very specific while providing credit facility to the borrowers. The banks before giving credit facilities should perform basic calculations of the borrowers’ capacity to pay the debt back. However, this only is not necessary, banks should regularly evaluate the financial position of the borrower companies.
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 which should evaluate the financial capacity of the borrower before than credit facility.
The credit rating agency should regularly evaluate the financial condition of the clients.
Special accounts should be made of the clients where monthly loan concentration reports should be made.
It is also wise for the banks to carryout special investigative audit of all financial and business transactions and books of accounts of the borrower company when there is possibility of the diversion of the funds and mismanagement.
The banks before providing the credit facilities to the borrower company should analyse the major heads of the income and expenditure based on the financial performance of the comparable companies in the industry to identify significant variances and seek explanation for the same from the company management. They should also analyse the current financial position of the major assets and liabilities.
Banks should evaluate the SWOT analysis of the borrowing companies i.e. how they would face the environmental threats and opportunities with the use of their strength and weakness, and what will be their possible future growth in concerned to financial and operational performance.
Independent settlement procedure should be more strict and faster and the decision made by the settlement committee should be binding both borrowers and lenders and any one of them failing to follow the decision of the settlement committee should be punished severely.
There should be proper monitoring of the restructured accounts because there is every possibility of the loans slipping into NPAs category again.
Proper training is important to the staff of the banks at the appropriate level with on going process. That how they should deal the problem of NPAs, and what continues steps they should take to reduce the NPAs.
Willful Default of Bank loans should be made a Criminal Offence.
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 is given to the report. A conclusion reveals the explanations about what the report has covered and what is the essence of the study. What my project report covers is concluded below. The problem statement on which I focused my study is “NPAs the big challenge before the Public Sector Banks”. The Indian banking sector is the important service sector that helps the people of the India to achieve the socio economic objective. The Indian banking sector has helped the business and service sector to develop by providing them credit facilities and other finance related facilities. The Indian banking sector is developing with good appreciate as compared to the global benchmark banks. The Indian banking system is classified into scheduled and non scheduled banks. The Public Sector Banks play very important role in developing the nation in terms of providing good financial services. The Public Sector Banks have also shown good performance in the last few 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 assets which 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 undertaken it 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 the smooth functioning of the recycling of the funds. If we analyse the past years data, we may come to know that the NPAs have 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 and which increased at faster rate in 2003 with 94,905crore. The Public Sector Banks involve its nearly 50% of share in the NPAs.Thus we can imagine how Public Sector 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 very lightly 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 in the nation. This would help the nation to develop more banking branches and developing the economy by providing the better financial services to the nation.
M Y Khan and Public Sector Banks K Jain “management Accounting” Tata McGraw-Hill Publishing Company Limited,new Delhi 1999.
Banking Finance (February 2003)
Banking Finance (April 2003)
IBA Bulletin (January 2004), (February 2003), Monthly journal published by Indian Banks’ Associations.
Banking Annual (Octomber 2003) published by Business Standard.
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