Management Research Project on NPA

MRP FINAL PROJECT REPORT

ON

COMPARATIVE ANALYSIS ON NON PERFORMING ASSETS OF PRIVATE AND PUBLIC SECTOR BANKS

BY ANINDYA SANKAR KUNDU (08BS0000328)

Management Research Project (Batch of 2010)

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PROJECT TITLE

COMPARATIVE ANALYSIS ON NON PERFORMING ASSETS OF PRIVATE AND PUBLIC SECTOR BANKS.

A report submitted in partial fulfillment of the requirements of MBA program

FACULTY GUIDE Prof. Rajasree Nandy ICFAI Business School KOCHI

SUBMITTED BY 2

ANINDYA SANKAR KUNDU (08BS0000328)

Declaration

I hereby declare that this MRP report on “COMPARATIVE PERFORMING ASSETS OF PRIVATE AND

ANALYSIS ON NON

PUBLIC SECTOR BANKS.”

has been

written and prepared by me during the academic year 2009-2010.This project was done under the able guidance and supervision of Prof. Rajasree Nandi, Finance Faculty, IBS Kochi in partial fulfillment of the requirement for the Master Of Business Administration Degree course of the ICFAI Business School.

I also declare that this project is the result of my own effort and has not been submitted to any other institution for the award of any Degree or Diploma.

Place: Kochi Anindya Sankar Kundu 08bs0000328

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Acknowledgements

If words are considered to be signs of gratitude then let these words convey the very same. I thank Prof. Rajasree Nandi, ICFAI Business School, Kochi, who has sincerely supported me with the valuable insights into the completion of this project. I am grateful to all faculty members of ICFAI Business School, Kochi and my friends who have helped me in the successful completion of this Management Research Project.

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TABLE OF CONTENTS

Declaration ………………………………………………………………………… ………………………………… 3 Acknowledgments ……………………………………………………………………… ………………………. 4 Abstract …………………………………………………………………………… ……………………………………. 7 1. Project Details 1.1 Objective of the project …………………………………………………………………… 9 1.2 Research Methodology…………………………………………………… …………………. 9 1.3 Scope of the project …………………………………………………………………… …… 9 1.4 Sampling Methods …………………………………………………………………… ……… 10 1.5 Limitations of the project……………………………………………………………… … 10 5

2. Introduction

2.1 Definition of NPA

……………………………………………………………………… ……... 12 2.2 NPAs: An issue for banks and FI’s in India ……………………………… 13 2.3 Indian economy and NPAs ……………………………………………………………. 13 2.4 Global developments and NPAs ………………………………………………….. 14 2.5 Factors for rise in NPAs…………………………………………………………………. 15 2.6 Problems due to NPA ……………………………………………………………………. 19 2.7 Types of NPA ……………………………………………………………………… ……………. 20 3. Income Recognition 3.1 Income Recognition Policy ................................................................. 22 3.2 Reversal of income ........................................................................... .... 22 3.3 Leased Assets ............................................................................ ............. 23 3.4 Interest Application ..................................................................... ........ 23 3.5 Reporting of NPAs ............................................................................... 24 6

4. Assets Classifications 4.1 Sub-standard Assets ..................................................................... ........ 26 4.2 Doubtful Assets ..................................................................... ................ 30 4.3 Loss Assets ............................................................................ .................. 31 5. Impact of NPA & Preventive Measurement for NPA 5.1 Impact of NPA ........................................................................................ 33 5.2 Early symptoms ...................................................................... ............... 34 5.3 Preventive Measurement for NPA .................................................. 35

6. Tools for recovery of NPA 6.1 Willful Default ………………………………………………………………… ………………… 39 6.2 Inability to Pay ………………………………………………………………… ………………. 40 6.3 Restructuring / Rescheduling of Loans …………………………………….. 41 7

6.4 Treatment of Restructured Standard Accounts …………………….. 41 6.5 Treatment of restructured sub-standard accounts ………………. 42 6.6 Up gradation of restructured accounts ……………………………………. 42 6.7 General ………………………………………………………………… …………………………….. 43 6.8 Income recognition ………………………………………………………………… ………. 43 6.9 Funded Interest ………………………………………………………………… …………….. 43 6.9.1 Conversion into equity, debentures or any other instrument 44 6.9.2 Provisioning ………………………………………………………………… ………………… 44 7. Special Cases 7.1.1 Accounts with temporary deficiencies ……………………………………… 46 7.1.2 Accounts regularized near about the balance sheet date ….. 46 7.1.3 Asset Classification to be borrower-wise and not facility-wise 7.1.4 Accounts where there is erosion in the value of security … 47 7.1.5 Advances to PACS/FSS ceded to Commercial Banks ………….. 47 7.1.6 Advances against Term Deposits, NSCs, KVP/IVP ………………. 48 7.1.7 Loans with moratorium for payment of interest …………………. 48 7.1.8 Agricultural advances ………………………………………………………………… … 48 8

7.1.9 Government guaranteed advances …………………………………………. 49 7.2.1 Take-out Finance ………………………………………………………………… ………… 49 7.2.2 Post-shipment Supplier's Credit ……………………………………………… 50 7.2.3 Export Project Finance ……………………………………………………………….. 50 7.2.4 Advances under rehabilitation approved by BIFR/ TLI …….. 50 7.2.5 Role of ARCIL ………………………………………………………………… …………….. 51 8. Data Analysis and interpretation ……………………………………………………….. 52 9. Annexure ……………………………………………………………………… ……………………………….. 64 10. Bibliography ……………………………………………………………………… ………………………… 65

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ABSTRACT The accumulation of huge non-performing assets in banks has assumed great importance. The depth of the problem of bad debts was first realized only in early 1990s. The magnitude of NPAs in banks and financial institutions is over Rs.1, 50,000 crore.

While gross NPA reflects the quality of the loans made by banks, net NPA shows the actual burden of banks. Now it is increasingly evident that the major defaulters are the big borrowers coming from the non-priority sector. The banks and financial institutions have to take the initiative to reduce NPAs in a time bound strategic approach.

Public sector banks figure prominently in the debate not only because they dominate the banking industries, but also since they have much larger NPAs compared with the private sector banks. This raises a concern in the industry and academia because it is generally felt that NPAs reduce the profitability of a bank, weaken its financial health and erode its solvency.

For the recovery of NPAs a broad framework has evolved for the management of NPAs under which several options are provided for debt recovery and restructuring. Banks and FIs have the freedom to design and implement their own policies for recovery and write-off incorporating compromise and negotiated settlements.

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CHAPTER-1 Project Details

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1.1 OBJECTIVES OF THE STUDY The basic idea behind undertaking the Grand Project on NPA was to: 

To evaluate NPAs (Gross and Net) in different banks.

 To study the past trends of NPA.  To calculate the weighted of NPA in risk management in Banking  To analyze financial performance of banks at different level of NPA

1.2 RESEARCH METHODOLOGY The research methodology adopted for carrying out the study were

 In this project Descriptive research methodologies were use. 

At the first stage theoretical study is attempted.

 At the second stage Historical study is attempted.  At the Third stage Comparative study of NPA is undertaken.

1.3 Scope of the Study 

Concept of Non-Performing Asset

 Guidelines  Impact of NPAs  Reasons for NPAs  Preventive Measures 12

 Tools to manage NPAs

1.4 Sampling Methods To prepare this Project we took five banks from public sector as well as five banks from private sector.

1.5 Limitations of the study  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.

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CHAPTER-2

INTRODUCTIO N 14

2. Introduction NPA. The three letters Strike terror in banking sector and business circle today. NPA is short form of “Non Performing Asset”. The dreaded NPA rule says simply this: when interest or other due to a bank remains unpaid for more than 90 days, the entire bank loan automatically turns a non performing asset. The recovery of loan has always been problem for banks and financial institution. To come out of these first we need to think is it possible to avoid NPA, no cannot be then left is to look after the factor responsible for it and managing those factors. 2.1 Definitions: An asset, including a leased asset, becomes nonperforming when it ceases to generate income for the bank. A ‘non-performing asset’ (NPA) was defined as a credit facility in respect of which the interest and/ or instalment of principal has remained ‘past due’ for a specified period of time.  With a view to moving towards international best practices and to ensure greater transparency, it has been decided to adopt the ‘90 days’ overdue’ norm for identification of NPAs, from the year ending March 31, 2004. Accordingly, with effect from March 31, 2004, a non-performing asset (NPA) shall be a loan or an advance where; Interest and/ or instalment 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), 15

 The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,  Interest and/or instalment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes. As a facilitating measure for smooth transition to 90 days norm, banks have been advised to move over to charging of interest at monthly rests, by April 1, 2002. However, the date of classification of an advance as NPA should not be changed on account of charging of interest at monthly rests. Banks should, therefore, continue to classify an account as NPA only if the interest charged during any quarter is not serviced fully within 180 days from the end of the quarter with effect from April 1, 2002 and 90 days from the end of the quarter with effect from March 31, 2004. 2.2 NPAs: AN ISSUE FOR BANKS AND FIs IN INDIA To start with, performance in terms of profitability is a benchmark for any business enterprise including the banking industry. However, increasing NPAs have a direct impact on banks profitability as legally banks are not allowed to book income on such accounts and at the sometime are forced to make provision on such assets as per the Reserve Bank of India (RBI) guidelines. Also, with increasing deposits made by the public in the banking system, the banking industry cannot afford defaults by borrower s since NPAs affects the repayment capacity of banks. Further, Reserve Bank of India (RBI) successfully creates excess liquidity in the system through various rate cuts and banks fail to utilize this benefit to its advantage due to the tear of burgeoning non-performing assets. 2.3 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 FIs, etc. 16

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 institution in India hold nonperforming assets worth Rs. 110000 crores Bankers have realized that unless the level of NPAs is reduced drastically, they will find it difficult to survive.

2.4 GLOBAL DEVELOPMENTS AND NPAs The core banking business is of mobilizing the deposits and utilizing it for lending to industry. Lending business is generally encouraged because it has the effect of funds being transferred from the system to productive purposes, which results into economic growth. However lending also carries credit risk, which arises from the failure of borrower to fulfill its contractual obligations either during the course of a transaction or on a future obligation. A question that arises is how much risk can a bank afford to take? Recent happenings in the business world -Enron, WorldCom, Xerox, Global Crossing do not give much confidence to banks. In case after case, these giant corporate becan1e bankrupt and failed to provide investors with clearer and more complete information thereby introducing a degree of risk that many investors could neither anticipate nor welcome. The history of financial institutions also reveals the fact that the biggest banking failures were due to credit risk. Due to this, banks are restricting their lending operations to secured avenues only with adequate collateral on which to fall back upon in a situation of default.

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2.5 FACTORS FOR RISE IN NPAs The banking sector has been facing the serious problems of the rising NPAs. But the problem of NPAs is more in public sector banks when compared to private sector banks and foreign banks. The NPAs in PSB are growing due to external as well as internal factors. 2.5.1 EXTERNAL FACTORS:-

Ineffective recovery tribunal The Govt. has set of numbers of recovery tribunals, which works for recovery of loans and advances. Due to their negligence and ineffectiveness in their work the bank suffers the consequence of non-recover, thereby reducing their profitability and liquidity. Willful Defaults

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There are borrowers who are able to pay back loans but are intentionally withdrawing it. These groups of people should be identified and proper measures should be taken in order to get back the money extended to them as advances and loans. Natural calamities This is the measure factor, which is creating alarming rise in NPAs of the PSBs. every now and then India is hit by major natural calamities thus making the borrowers unable to pay back there loans. Thus the bank has to make large amount of provisions in order to compensate those loans, hence end up the fiscal with a reduced profit. Mainly ours farmers depends on rain fall for cropping. Due to irregularities of rain fall the farmers are not to achieve the production level thus they are not repaying the loans. Industrial sickness Improper project handling , ineffective management , lack of adequate resources , lack of advance technology , day to day changing govt. Policies give birth to industrial sickness. Hence the banks that finance those industries ultimately end up with a low recovery of their loans reducing their profit and liquidity. Lack of demand Entrepreneurs in India could not foresee their product demand and starts production which ultimately piles up their product thus making them unable to pay back the money they borrow to operate these activities. The banks recover the amount by selling of their assets, which covers a minimum label. Thus the banks record the non-recovered part as NPAs and has to make provision for it.  Change on Govt. policies With every new govt. banking sector gets new policies for its operation. Thus it has to cope with the changing principles and policies for the regulation of the rising of NPAs. The fallout of handloom sector is continuing as most of the weavers Co-operative societies have become defunct largely due to withdrawal of 19

state patronage. The rehabilitation plan worked out by the Central government to revive the handloom sector has not yet been implemented. So the over dues due to the handloom sectors are becoming NPAs.

2.5.2 INTERNAL FACTORS: Defective Lending process

There are three cardinal principles of bank lending that have been followed by the commercial banks since long. i. Principles of safety ii. Principle of liquidity iii. Principles of profitability i.

Principles of safety :By safety it means that the borrower is in a position to repay the loan both principal and interest. The repayment of loan depends upon the borrowers: a) Capacity to pay b) Willingness to pay

a) Capacity to pay depends upon: 1. Tangible assets 2. Success in business b) Willingness to pay depends on: 1. Character 2. Honest 3. Reputation of borrower The banker should, therefore take utmost care in ensuring that the enterprise or business for which a loan is sought is a sound one and the borrower is capable of carrying it out successfully .He should be a person of integrity and good character.  Inappropriate technology Due to inappropriate technology and management information system, market driven decisions on real time basis cannot be taken. Proper MIS and financial accounting system is not implemented in the banks, which leads to poor credit collection, thus NPA. All the branches of the bank should be computerized. 20

 Improper SWOT analysis The improper strength, weakness, opportunity and threat analysis is another reason for rise in NPAs. While providing unsecured advances the banks depend more on the honesty, integrity, and financial soundness and credit worthiness of the borrower. Banks should consider the borrowers own capital investment. • it should collect credit information of the borrowers from_ a. From bankers. b. Enquiry from market/segment of trade, industry, business. c. From external credit rating agencies. • Analyze the balance sheet. True picture of business will be revealed on analysis of profit/loss a/c and balance sheet. • Purpose of the loan When bankers give loan, he should analyze the purpose of the loan. To ensure safety and liquidity, banks should grant loan for productive purpose only. Bank should analyze the profitability, viability, long term acceptability of the project while financing. •

 Poor credit appraisal system Poor credit appraisal is another factor for the rise in NPAs. Due to poor credit appraisal the bank gives advances to those who are not able to repay it back. They should use good credit appraisal to decrease the NPAs.  Managerial deficiencies The banker should always select the borrower very carefully and should take tangible assets as security to safe guard its interests. When accepting securities banks should consider the_ 1. Marketability 2. Acceptability 21

3. Safety 4. Transferability. The banker should follow the principle of diversification of risk based on the famous maxim “do not keep all the eggs in one basket”; it means that the banker should not grant advances to a few big farms only or to concentrate them in few industries or in a few cities. If a new big customer meets misfortune or certain traders or industries affected adversely, the overall position of the bank will not be affected. Like OSCB suffered loss due to the OTM Cuttack, and Orissa hand loom industries. The biggest defaulters of OSCB are the OTM (117.77lakhs), and the handloom sector Orissa hand loom WCS ltd (2439.60lakhs).  Absence of regular industrial visit The irregularities in spot visit also increases the NPAs. Absence of regularly visit of bank officials to the customer point decreases the collection of interest and principals on the loan. The NPAs due to willful defaulters can be collected by regular visits.  Re loaning process Non remittance of recoveries to higher financing agencies and re loaning of the same have already affected the smooth operation of the credit cycle. Due to re loaning to the defaulters and CCBs and PACs, the NPAs of OSCB is increasing day by day.

2.6 PROBLEMS DUE TO NPA 1.

Owners do not receive a market return on their capital .in the worst case, if the banks fails, owners lose their assets. 22

In modern times this may affect a broad pool of shareholders. 2.

Depositors do not receive a market return on saving. In the worst case if the bank fails, depositors lose their assets or uninsured balance.

3. Banks redistribute losses to other borrowers by charging higher interest rates, lower deposit rates and higher lending rates repress saving and financial market, which hamper economic growth. 4.

Nonperforming loans epitomize bad investment. They misallocate credit from good projects, which do not receive funding, to failed projects. Bad investment ends up in misallocation of capital, and by extension, labor and natural resources.

Nonperforming asset may spill over the banking system and contract the money stock, which may lead to economic contraction. This spillover effect can channelize through liquidity or bank insolvency: a) When many borrowers fail to pay interest, banks may experience liquidity shortage. This can jam payment across the country. b) Illiquidity constraints bank in paying depositors c) Undercapitalized banks exceed the bank’s capital base. 'Out of Order' status: An account should be treated as 'out of order' if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for six months as on the date of Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as 'out of order'. ‘Overdue’:

Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on the due date fixed by the bank. 23

2.7 Types of NPA A] Gross NPA B] Net NPA A] Gross NPA: Gross NPAs are the sum total of all loan assets that are classified as NPAs as per RBI guidelines as on Balance Sheet date. Gross NPA reflects the quality of the loans made by banks. It consists of all the non-standard assets like as sub-standard, doubtful, and loss assets. It can be calculated with the help of following ratio: Gross NPAs Ratio  Gross NPAs Gross Advances B] Net NPA: Net NPAs are those type of NPAs in which the bank has deducted the provision regarding NPAs. Net NPA shows the actual burden of banks. Since in India, bank balance sheets contain a huge amount of NPAs and the process of recovery and write off of loans is very time consuming, the provisions the banks have to make against the NPAs according to the central bank guidelines, are quite significant. That is why the difference between gross and net NPA is quite high. It can be calculated by following Net NPAs  Gross NPAs – Provisions Gross Advances - Provisions

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CHAPTER-3

INCOME RECOGNITION

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3. INCOME RECOGNITION 3.1. Income recognition – Policy ➢ The policy of income recognition has to be objective and based on the record of recovery. Internationally income from non-performing assets (NPA) is not recognised on accrual basis but is booked as income only when it is actually received. Therefore, the banks should not charge and take to income account interest on any NPA. ➢ However, interest on advances against term deposits, NSCs, IVPs, KVPs and Life policies may be taken to income account on the due date, provided adequate margin is available in the accounts. ➢ Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding debts should be recognised on an accrual basis over the period of time covered by the re-negotiated or rescheduled extension of credit. ➢

If Government guaranteed advances become NPA, the interest on such advances should not be taken to income account unless the interest has been realised.

3.2. Reversal of income:

➢

If any advance, including bills purchased and discounted, becomes NPA as at the close of any year, interest accrued and credited to income account in the corresponding previous year, should be reversed or provided for if the same is not realised. This will apply to Government guaranteed accounts also.

➢ In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected. 26

3.3 Leased Assets  The net lease rentals (finance charge) on the leased asset accrued and credited to income account before the asset became non-performing, and remaining unrealised, should be reversed or provided for in the current accounting period.  The term 'net lease rentals' would mean the amount of finance charge taken to the credit of Profit & Loss Account and would be worked out as gross lease rentals adjusted by amount of statutory depreciation and lease equalisation account.  As per the 'Guidance Note on Accounting for Leases' issued by the Council of the Institute of Chartered Accountants of India (ICAI), a separate Lease Equalisation Account should be opened by the banks with a corresponding debit or credit to Lease Adjustment Account, as the case may be. Further, Lease Equalisation Account should be transferred every year to the Profit & Loss Account and disclosed separately as a deduction from/addition to gross value of lease rentals shown under the head 'Gross Income'. Appropriation of recovery in NPAs ➢ Interest realised on NPAs may be taken to income account provided the credits in the accounts towards interest are not out of fresh/ additional credit facilities sanctioned to the borrower concerned. ➢

In the absence of a clear agreement between the bank and the borrower for the purpose of appropriation of recoveries in NPAs (i.e. towards principal or interest due), banks should adopt an accounting principle and exercise the right of appropriation of recoveries in a uniform and consistent manner. 27

3.4 Interest Application: There is no objection to the banks using their own discretion in debiting interest to an NPA account taking the same to Interest Suspense Account or maintaining only a record of such interest in proforma accounts.

3.5 Reporting of NPAs ➢

Banks are required to furnish a Report on NPAs as on 31st March each year after completion of audit. The NPAs would relate to the banks’ global portfolio, including the advances at the foreign branches. The Report should be furnished as per the prescribed format given in the Annexure I.

➢ While reporting NPA figures to RBI, the amount held in interest suspense account, should be shown as a deduction from gross NPAs as well as gross advances while arriving at the net NPAs. Banks which do not maintain Interest Suspense account for parking interest due on non-performing advance accounts, may furnish the amount of interest receivable on NPAs as a foot note to the Report. ➢ Whenever NPAs are reported to RBI, the amount of technical write off, if any, should be reduced from the outstanding gross advances and gross NPAs to eliminate any distortion in the quantum of NPAs being reported. REPORTING FORMAT FOR NPA – GROSS AND NET NPA Annexure-I (Page no-64)

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CHAPTER-4 -

Asset Classification - Provisioning Norms

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4. Asset Classification Categories of NPAs Standard Assets: Standard assets are the ones in which the bank is receiving interest as well as the principal amount of the loan regularly from the customer. Here it is also very important that in this case the arrears of interest and the principal amount of loan do not exceed 90 days at the end of financial year. If asset fails to be in category of standard asset that is amount due more than 90 days then it is NPA and NPAs are further need to classify in sub categories. Banks are required to classify nonperforming assets further into the following three categories based on the period for which the asset has remained nonperforming and the reliability of the dues: ( 1 ) Sub-standard Assets ( 2 ) Doubtful Assets ( 3 ) Loss Assets ( 1 ) Sub-standard Assets:-With effect from 31 March 2005, a substandard asset would be one, which has remained NPA for a period less than or equal to 12 month. The following features are exhibited by substandard assets: the current net worth of the borrowers / guarantor or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full; and the asset has well-defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. 30

( 2 ) Doubtful Assets:-A loan classified as doubtful has all the weaknesses inherent in assets that were classified as sub-standard, with the added characteristic that the weaknesses make collection or liquidation in full, – on the basis of currently known facts, conditions and values – highly questionable and improbable. With effect from March 31, 2005, an asset would be classified as doubtful if it remained in the sub-standard category for 12 months. ( 3 ) Loss Assets:-A loss asset is one which considered uncollectible and of such little value that its continuance as a bankable asset is not warranted- although there may be some salvage or recovery value. Also, these assets would have been identified as ‘loss assets’ by the bank or internal or external auditors or the RBI inspection but the amount would not have been written-off wholly.

Provisioning Norms General ➢ In order to narrow down the divergences and ensure adequate provisioning by banks, it was suggested that a bank's statutory auditors, if they so desire, could have a dialogue with RBI's Regional Office/ inspectors who carried out the bank's inspection during the previous year with regard to the accounts contributing to the difference. ➢ Pursuant to this, regional offices were advised to forward a list of individual advances, where the variance in the provisioning requirements between the RBI and the bank is above certain cut off levels so that the bank and the statutory auditors take into account the assessment of the RBI while making provisions for loan loss, etc. ➢ The primary responsibility for making adequate provisions for any diminution in the value of loan assets, investment or other assets is that of the bank managements and the statutory auditors. The assessment made by the inspecting officer of the RBI is furnished to the bank to assist the bank management and the statutory auditors in taking a decision in regard to making adequate and necessary provisions in terms of prudential guidelines. 31

➢ In conformity with the prudential norms, provisions should be made on the non-performing assets on the basis of classification of assets into prescribed categories as detailed in paragraphs 4 supra. Taking into account the time lag between an account becoming doubtful of recovery, its recognition as such, the realisation of the security and the erosion over time in the value of security charged to the bank, the banks should make provision against sub-standard assets, doubtful assets and loss assets as below: Loss assets: The entire asset should be written off. If the assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for.

Doubtful assets: ➢ 100 percent of the extent to which the advance is not covered by the realisable value of the security to which the bank has a valid recourse and the realisable value is estimated on a realistic basis. ➢ In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 20 percent to 50 percent of the secured portion depending upon the period for which the asset has remained doubtful: Period for which the advance has been considered as doubtful

Provision requirement (%)

Up to one year

20

One to three years

30

More than three years:

60% with effect from March

(1)Outstanding stock of 32

NPAs as on March 31, 2004. (2)Advances classified as ‘doubtful’ more than three years on or after April 1, 2004.

31,2005. 75% effect from March 31, 2006. 100% with effect from March 31, 2007.

➢ Additional provisioning consequent upon the change in the definition of doubtful assets effective from March 31, 2003 has to be made in phases as under:  As on 31.03.2003, 50 percent of the additional provisioning requirement on the assets which became doubtful on account of new norm of 18 months for transition from sub-standard asset to doubtful category.  As on 31.03.2002, balance of the provisions not made during the previous year, in addition to the provisions needed, as on 31.03.2002. ➢ Banks are permitted to phase the additional provisioning consequent upon the reduction in the transition period from substandard to doubtful asset from 18 to 12 months over a four year period commencing from the year ending March 31, 2005, with a minimum of 20 % each year. Note: Valuation of Security for provisioning purposes

With a view to bringing down divergence arising out of difference in assessment of the value of security, in cases of NPAs with balance of Rs. 5 crore and above stock audit at annual intervals by external agencies appointed as per the guidelines approved by the Board would be mandatory in order to enhance the reliability on stock valuation. Valuers appointed as per the guidelines approved by the Board of Directors should get collaterals such as immovable properties charged in favour of the bank valued once in three years. Sub-standard assets: A general provision of 10 percent on total outstanding should be made without making any allowance for DICGC/ECGC guarantee cover and securities available. Standard assets: 33

➢

From the year ending 31.03.2000, the banks should make a general provision of a minimum of 0.40 percent on standard assets on global loan portfolio basis.

➢ The provisions on standard assets should not be reckoned for arriving at net NPAs. ➢ The provisions towards Standard Assets need not be netted from gross advances but shown separately as 'Contingent Provisions against Standard Assets' under 'Other Liabilities and Provisions - Others' in Schedule 5 of the balance sheet. Floating provisions: Some of the banks make a 'floating provision' over and above the specific provisions made in respect of accounts identified as NPAs. The floating provisions, wherever available, could be set-off against provisions required to be made as per above stated provisioning guidelines. Considering that higher loan loss provisioning adds to the overall financial strength of the banks and the stability of the financial sector, banks are urged to voluntarily set apart provisions much above the minimum prudential levels as a desirable practice.

Provisions on Leased Assets: Leases are peculiar transactions where the assets are not recorded in the books of the user of such assets as Assets, whereas they are recorded in the books of the owner even though the physical existence of the asset is with the user (lessee). __(AS19 ICAI)

Sub-standard assets :  10 percent of the 'net book value'.  As per the 'Guidance Note on Accounting for Leases' issued by the ICAI, 'Gross book value' of a fixed asset is its historical cost or other amount substituted for historical cost in the 34

books of account or financial statements. Statutory depreciation should be shown separately in the Profit & Loss Account. Accumulated depreciation should be deducted from the Gross Book Value of the leased asset in the balance sheet of the lesser to arrive at the 'net book value'.  Also, balance standing in 'Lease Adjustment Account' should be adjusted in the 'net book value' of the leased assets. The amount of adjustment in respect of each class of fixed assets may be shown either in the main balance sheet or in the Fixed Assets Schedule as a separate column in the section related to leased assets. 

Doubtful assets

:100 percent of the extent to which the finance is not secured by the realisable value of the leased asset. Realisable value to be estimated on a realistic basis. In addition to the above provision, the following provision on the net book value of the secured portion should be made, depending upon the period for which asset has been doubtful:

Period

%age provision

Up to one year

20

One to three years

30

More years

than

of

three 50

Loss assets

:The entire asset should be written-off. If for any reason, an asset is allowed to remain in books, 100 percent of the sum of the net investment in the lease and the unrealised portion of finance income net of finance charge component should be provided for. (‘Net book value') 

Guidelines for Provisions under Special Circumstances 35

Government guaranteed advances  With effect from 31 March 2000, in respect of advances sanctioned against State Government guarantee, if the guarantee is invoked and remains in default for more than two quarters (180 days at present), the banks should make normal provisions as prescribed in paragraph 4.1.2 above.  As regards advances guaranteed by State Governments, in respect of which guarantee stood invoked as on 31.03.2000, necessary provision was allowed to be made, in a phased manner, during the financial years ending 31.03.2000 to 31.03.2003 with a minimum of 25 percent each year.

36

CHAPTER-5 -

Impact of NPA Preventive Measurement for

NPA

4.Impact of NPA 

Profitability:NPA means booking of money in terms of bad asset, which occurred due to wrong choice of client. Because of the money getting blocked the prodigality of bank decreases not only by the amount of NPA but NPA lead to opportunity 37

cost also as that much of profit invested in some return earning project/asset. So NPA doesn’t affect current profit but also future stream of profit, which may lead to loss of some long-term beneficial opportunity. Another impact of reduction in profitability is low ROI (return on investment), which adversely affect current earning of bank.



Liquidity:Money is getting blocked, decreased profit lead to lack of enough cash at hand which lead to borrowing money for shot\rtes period of time which lead to additional cost to the company. Difficulty in operating the functions of bank is another cause of NPA due to lack of money. Routine payments and dues.

 Involvement of management:Time and efforts of management is another indirect cost which bank has to bear due to NPA. Time and efforts of management in handling and managing NPA would have diverted to some fruitful activities, which would have given good returns. Now day’s banks have special employees to deal and handle NPAs, which is additional cost to the bank.

 Credit loss:Bank is facing problem of NPA then it adversely affect the value of bank in terms of market credit. It will lose it’s goodwill and brand image and credit which have negative impact to the people who are putting their money in the banks.

5.2 Early symptoms by which one can recognize a performing asset turning in to Non-performing asset:38

Four categories of early symptoms:--------------------------------------------------(1) Financial: ✔ Non-payment of the very first instalment in case of term loan. ✔ Bouncing of cheque due to insufficient balance in the accounts. ✔ Irregularity in instalment. ✔ Irregularity of operations in the accounts. ✔ Unpaid overdue bills. ✔ Declining Current Ratio. ✔ Payment which does not cover the interest and principal amount of that instalment. ✔ While monitoring the accounts it is found that partial amount is diverted to sister concern or parent company. (2) Operational and Physical: ✔ If information is received that the borrower has either initiated the process of winding up or are not doing the business. ✔ Overdue receivables. ✔ Stock statement not submitted on time. ✔ External non-controllable factor like natural calamities in the city where borrower conduct his business. ✔ Frequent changes in plan. ✔ Non-payment of wages. (3) Attitudinal Changes: ✔ Avoidance of contact with bank. ✔ Problem between partners. (4) Others: ✔ Changes in Government policies. ✔ Death of borrower. ✔ Competition in the market.

5.3 Preventive Measurement for NPA 39

Early Recognition of the Problem:Invariably, by the time banks start their efforts to get involved in a revival process, it’s too late to retrieve the situation- both in terms of rehabilitation of the project and recovery of bank’s dues. Identification of weakness in the very beginning that is: When the account starts showing first signs of weakness regardless of the fact that it may not have become NPA, is imperative. Assessment of the potential of revival may be done on the basis of a techno-economic viability study. Restructuring should be attempted where, after an objective assessment of the promoter’s intention, banks are convinced of a turnaround within a scheduled timeframe. In respect of totally unviable units as decided by the bank, it is better to facilitate winding up/ selling of the unit earlier, so as to recover whatever is possible through legal means before the security position becomes worse. Identifying Borrowers with Genuine Intent:Identifying borrowers with genuine intent from those who are non- serious with no commitment or stake in revival is a challenge confronting bankers. Here the role of frontline officials at the branch level is paramount as they are the ones who has intelligent inputs with regard to promoters’ sincerity, and capability to achieve turnaround. Based on this objective assessment, banks should decide as quickly as possible whether it would be worthwhile to commit additional finance. In this regard banks may consider having “Special Investigation” of all financial transaction or business transaction, books of account in order to ascertain real factors that contributed to sickness of the borrower. Banks may have penal of technical experts with proven expertise and track record of preparing techno-economic study of the project of the borrowers. Borrowers having genuine problems due to temporary mismatch in fund flow or sudden requirement of additional fund may be entertained at branch level, and for this purpose a special limit to such type of cases should be decided. This will obviate the need to route the additional funding through the controlling offices in deserving cases, and help avert many accounts slipping into NPA category. 40

Timeliness and Adequacy of response:Longer the delay in response, grater the injury to the account and the asset. Time is a crucial element in any restructuring or rehabilitation activity. The response decided on the basis of techno-economic study and promoter’s commitment, has to be adequate in terms of extend of additional funding and relaxations etc. under the restructuring exercise. The package of assistance may be flexible and bank may look at the exit option. Focus on Cash Flows:While financing, at the time of restructuring the banks may not be guided by the conventional fund flow analysis only, which could yield a potentially misleading picture. Appraisal for fresh credit requirements may be done by analysing funds flow in conjunction with the Cash Flow rather than only on the basis of Funds Flow. Management Effectiveness:The general perception among borrower is that it is lack of finance that leads to sickness and NPAs. But this may not be the case all the time. Management effectiveness in tackling adverse business conditions is a very important aspect that affects a borrowing unit’s fortunes. A bank may commit additional finance to an aling unit only after basic viability of the enterprise also in the context of quality of management is examined and confirmed. Where the default is due to deeper malady, viability study or investigative audit should be done – it will be useful to have consultant appointed as early as possible to examine this aspect. A proper techno economic viability study must thus become the basis on which any future action can be considered. Multiple Financing:A. During the exercise for assessment of viability and restructuring, a Pragmatic and unified approach by all the lending banks/ FIs as also sharing of all relevant information on 41

the borrower would go a long way toward overall success of rehabilitation exercise, given the probability of success/failure. B. In some default cases, where the unit is still working, the bank should make sure that it captures the cash flows (there is a tendency on part of the borrowers to switch bankers once they default, for fear of getting their cash flows forfeited), and ensure that such cash flows are used for working capital purposes. Toward this end, there should be regular flow of information among consortium members. A bank, which is not part of the consortium, may not be allowed to offer credit facilities to such defaulting clients. Current account facilities may also be denied at no consortium banks to such clients and violation may attract penal action. The Credit Information Bureau of India Ltd.(CIBIL) may be very useful for meaningful information exchange on defaulting borrowers once the setup becomes fully operational. C. In a forum of lenders, the priority of each lender will be different. While one set of lenders may be willing to wait for a longer time to recover its dues, another lender may have a much shorter timeframe in mind. So it is possible that the letter categories of lenders may be willing to exit, even a t a cost – by a discounted settlement of the exposure. Therefore, any plan for restructuring/rehabilitation may take this aspect into account. D. Corporate Debt Restructuring mechanism has been institutionalized in 2001 to provide a timely and transparent system for restructuring of the corporate debt of Rs. 20 crore and above with the banks and FIs on a voluntary basis and outside the legal framework. Under this system, banks may greatly benefit in terms of restructuring of large standard accounts (potential NPAs) and viable sub-standard accounts with consortium/multiple banking arrangements.

42

CHAPTER-6 Tools For recovery of npa

43

Once NPA occurred, one must come out of it or it should be managed in most efficient manner. Legal ways and means are there to overcome and manage NPAs. We will look into each one of it.

6.1 Willful Default:A] Lok Adalat and Debt Recovery Tribunal B] Securitization Act 44

C] Asset Reconstruction

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

Debt Recovery Tribunals (DRT): The recovery of debts due to banks and financial institution passed in March 2000 has helped in strengthening the function of DRTs. Provision for placement of more than one recovery officer, power to attach defendant’s property/assets before judgment, penal provision for disobedience of tribunal’s order or for breach of any terms of order and appointment of receiver with power of realization, management, protection and preservation of property are expected to provide necessary teeth to the DRTs and speed up the recovery of NPAs in the times to come. DRTs which have been set up by the Government to facilitate speedy recovery by banks/DFIs, have not been able make much impact on loan recovery due to variety of reasons like inadequate number, lack of infrastructure, under staffing and frequent adjournment of cases. It is essential that DRT mechanism is strengthened and vested with a proper enforcement mechanism to enforce their orders. Non observation of any order passed by the tribunal should amount to contempt of court, the DRT should have right to initiate contempt proceedings. The DRT should empowered to sell asset of the debtor companies and forward the proceed to the winding – up court for distribution among the lenders.

6.2 Inability to Pay Consortium arrangements: Asset classification of accounts under consortium should be based on the record of recovery of the individual member banks and other aspects having a bearing on the recoverability of the advances. Where the remittances by the 45

borrower under consortium lending arrangements are pooled with one bank and/or where the bank receiving remittances is not parting with the share of other member banks, the account will be treated as not serviced in the books of the other member banks and therefore, be treated as NPA. The banks participating in the consortium should, therefore, arrange to get their share of recovery transferred from the lead bank or get an express consent from the lead bank for the transfer of their share of recovery, to ensure proper asset classification in their respective books.

6.3 Restructuring / Rescheduling of Loans

A standard asset where the terms of the loan agreement regarding Interest and principal have been renegotiated or rescheduled after commencement of production should be classified as sub-standard and should remain in such category for at least one year of satisfactory performance under the renegotiated or rescheduled terms. In the case of sub-standard and doubtful assets also, rescheduling does not entitle a bank to upgrade the quality of advance automatically unless there is satisfactory performance under the rescheduled / renegotiated terms. Following representations from banks that the foregoing stipulations deter the banks from restructuring of standard and sub-standard loan assets even though the modification of terms might not jeopardize the assurance of repayment of dues from the borrower, the norms relating to restructuring of standard and sub-standard assets were reviewed in March 2001. In the context of restructuring of the accounts, the following stages at which the restructuring / rescheduling / renegotiation of the terms of loan agreement could take place, can be identified: 1) Before commencement of commercial production; 2) After commencement of commercial production but before the asset has been classified as substandard, 3) After commencement of commercial production and after the asset has been classified as substandard. In each of the foregoing three stages, the rescheduling, etc., of principal and/or of interest could take place, with or without sacrifice, as part of the restructuring package evolved.

6.4 Treatment of Restructured Standard Accounts: A rescheduling of the installments of principal alone, at any of the aforesaid first two stages would not cause a standard 46

asset to be classified in the substandard category provided the loan/credit facility is fully secured. A rescheduling of interest element at any of the foregoing first two stages would not cause an asset to be downgraded to substandard category subject to the condition that the amount of sacrifice, if any, in the element of interest, measured in present value terms, is either written off or provision is made to the extent of the sacrifice involved. For the purpose, the future interest due as per the original loan agreement in respect of an account should be discounted to the present value at a rate appropriate to the risk category of the borrower (i.e., current PLR+ the appropriate credit risk premium for the borrower-category) and compared with the present value of the dues expected to be received under the restructuring package, discounted on the same basis. In case there is a sacrifice involved in the amount of interest in present value terms, as at (b) above, the amount of sacrifice should either be written off or provision made to the extent of the sacrifice involved.

6.5 Treatment of restructured sub-standard accounts: A rescheduling of the installments of principal alone would render a sub-standard asset eligible to be continued in the sub-standard category for the specified period, provided the loan/credit facility is fully secured. A rescheduling of interest element would render a sub-standard asset eligible to be continued to be classified in substandard category for the specified period subject to the condition that the amount of sacrifice, if any, in the element of interest, measured in present value terms, is either written off or provision is made to the extent of the sacrifice involved. For the purpose, the future interest due as per the original loan agreement in respect of an account should be discounted to the present value at a rate appropriate to the risk category of the borrower (i.e., current PLR + the appropriate credit risk premium for the borrower category) and compared with the present value of the dues expected to be received under the restructuring package, discounted on the same basis. In case there is a sacrifice involved in the amount of interest in present value terms, as at (b) above, the amount of sacrifice should either be written off or provision made to the extent of the sacrifice involved. Even in cases where the 47

sacrifice is by way of write off of the past interest dues, the asset should continue to be treated as sub-standard.

6.6 Up gradation of restructured accounts: The sub-standard accounts which have been subjected to restructuring etc., whether in respect of principal installment or interest amount, by whatever modality, would be eligible to be upgraded to the standard category only after the specified period i.e., a period of one year after the date when first payment of interest or of principal, whichever is earlier, falls due, subject to satisfactory performance during the period. The amount of provision made earlier, net of the amount provided for the sacrifice in the interest amount in present value terms as aforesaid, could also be reversed after the one year period. During this one-year period, the substandard asset will not deteriorate in its classification if satisfactory performance of the account is demonstrated during the period. In case, however, the satisfactory performance during the one-year period is not evidenced, the asset classification of the restructured account would be governed as per the applicable prudential norms with reference to the pre restructuring payment schedule.

6.7 General: These instructions would be applicable to all type of credit facilities including working capital limits, extended to industrial units, provided they are fully covered by tangible securities. As trading involves only buying and selling of commodities and the problems associated with manufacturing units such as bottleneck in commercial production, time and cost escalation etc. are not applicable to them, these guidelines should not be applied to restructuring/ rescheduling of credit facilities extended to traders. While assessing the extent of security cover available to the credit facilities, which are being restructured/ rescheduled, collateral security would also be reckoned, provided such collateral is a tangible security properly charged to the bank and is not in the intangible form like guarantee etc. of the promoter/ others. 48

6.8 Income recognition There will be no change in the existing instructions on income recognition. Consequently, banks should not recognise income on accrual basis in respect of the projects even though the asset is classified as a standard asset if the asset is a "non performing asset" in terms of the extant instructions. In other words, while the accounts of the project may be classified as a standard asset, banks shall recognise income in such accounts only on realisation on cash basis if the asset has otherwise become ‘non performing’ as per the extant delinquency norm of 180 days. The delinquency norm would become 90 days with effect from 31 March 2004. Consequently, banks, which have wrongly recognised income in the past, should reverse the interest if it was recognised as income during the current year or make a provision for an equivalent amount if it was recognised as income in the previous year(s). As regards the regulatory treatment of income recognised as ‘funded interest’ and ‘conversion into equity, debentures or any other instrument’ banks should adopt the following:

6.9 Funded Interest: Income recognition in respect of the NPAs, regardless of whether these are or are not subjected to restructuring/ rescheduling/ renegotiation of terms of the loan agreement, should be done strictly on cash basis, only on realisation and not if the amount of interest overdue has been funded. If, however, the amount of funded interest is recognised as income, a provision for an equal amount should also be made simultaneously. In other words, any funding of interest in respect of NPAs, if recognised as income, should be fully provided for.

6.9.1. Conversion into equity, debentures or any other instrument: The amount outstanding converted into other instruments would normally comprise principal and the interest components. If the amount of interest dues is converted into equity or any other instrument, and income is recognised in consequence, full provision should be made for the amount of income so recognised to offset the effect of such income recognition. Such provision would be in addition to the amount of provision that may be necessary for the depreciation in the value of the equity or other instruments, as per the investment valuation norms. However, if the conversion of interest is into 49

equity, which is quoted, interest income can be recognised at market value of equity, as on the date of conversion, not exceeding the amount of interest converted to equity. Such equity must thereafter be classified in the "available for sale" category and valued at lower of cost or market value. In case of conversion of principal and /or interest in respect of NPAs into debentures, such debentures should be treated as NPA, ab initio, in the same asset classification as was applicable to loan just before conversion and provision made as per norms. This norm would also apply to zero coupon bonds or other Instruments which seek to defer the liability of the issuer. On such debentures, income should be recognised only on realisation basis. The income in respect of unrealised interest, which is converted into debentures or any other fixed maturity instrument, should be recognised only on redemption of such instrument. Subject to the above, the equity shares or other instruments arising from conversion of the principal amount of loan would also be subject to the usual prudential valuation norms as applicable to such instruments.

6.9.2. Provisioning While there will be no change in the extant norms on provisioning for NPAs, banks which are already holding provisions against some of the accounts, which may now be classified as ‘standard’, shall continue to hold the provisions and shall not reverse the same.

50

CHAPTER-7 Special Cases

7. Special Cases 7.1.1. Accounts with temporary deficiencies: The classification of an asset as NPA should be based on the record of recovery. Bank should not classify an advance account as NPA merely due to the existence of some deficiencies which are temporary in nature such as nonavailability of adequate drawing power based on the latest 51

available stock statement, balance outstanding exceeding the limit temporarily, non-submission of stock statements and nonrenewal of the limits on the due date, etc. In the matter of classification of accounts with such deficiencies banks may follow the following guidelines: Banks should ensure that drawings in the working capital accounts are covered by the adequacy of current assets, since current assets are first appropriated in times of distress. Drawing power is required to be arrived at based on the stock statement which is current. However, considering the difficulties of large borrowers, stock statements relied upon by the banks for determining drawing power should not be older than three months. The outstanding in the account based on drawing power calculated from stock statements older than three months, would be deemed as irregular. A working capital borrower account will become NPA if such irregular drawings are permitted in the account for a continuous period of 180 days even though the unit may be working or the borrower's financial position is satisfactory. Regular and ad hoc credit limits need to be reviewed/ regularized not later than three months from the due date/date of ad hoc sanction. In case of constraints such as non-availability of financial statements and other data from the borrowers, the branch should furnish evidence to show that renewal/ review of credit limits is already on and would be completed soon. In any case, delay beyond six months is not considered desirable as a general discipline. Hence, an account where the regular/ ad hoc credit limits have not been reviewed/ renewed within 180 days from the due date/ date of ad hoc sanction will be treated as NPA. 7.1.2.

Accounts regularized near about the balance sheet date:

The asset classification of borrower accounts where a solitary or a few credits are recorded before the balance sheet date should be handled with care and without scope for subjectivity. Where the account indicates inherent weakness on the basis of the data available, the account should be deemed as a NPA. In other genuine cases, the banks must furnish satisfactory evidence to the Statutory Auditors/Inspecting Officers about the manner of regularization of the account to eliminate doubts on their performing status.

52

7.1.3Asset Classification to be borrower-wise and not facility-wise It is difficult to envisage a situation when only one facility to a borrower becomes a problem credit and not others. Therefore, all the facilities granted by a bank to a borrower will have to be treated as NPA and not the particular facility or part thereof which has become irregular. If the debits arising out of devolvement of letters of credit or invoked guarantees are parked in a separate account, the balance outstanding in that account also should be treated as a part of the borrower’s principal operating account for the purpose of application of prudential norms on income recognition, asset classification and provisioning.

7.1.4. Accounts where there is erosion in the value of security A NPA need not go through the various stages of classification in cases of serious credit impairment and such assets should be straightaway classified as doubtful or loss asset as appropriate. Erosion in the value of security can be reckoned as significant when the realizable value of the security is less than 50 per cent of the value assessed by the bank or accepted by RBI at the time of last inspection, as the case may be. Such NPAs may be straightaway classified under doubtful category and provisioning should be made as applicable to doubtful assets. If the realizable value of the security, as assessed by the bank/ approved values/ RBI is less than 10 per cent of the outstanding in the borrower accounts, the existence of security should be ignored and the asset should be straightaway classified as loss asset. It may be either written off or fully provided for by the bank. 7.1.5. Advances to PACS/FSS ceded to Commercial Banks: In respect of agricultural advances as well as advances for other purposes granted by banks to ceded PACS/ FSS under the on-lending system, only that particular credit facility granted to PACS/ FSS which is in default for a period of two harvest seasons (not exceeding two half years)/two quarters, as the case may be, after it has become due will be classified as NPA and not all the credit facilities sanctioned to a PACS/ FSS. The other direct loans & advances, if any, granted by the bank to the member borrower of a PACS/ FSS outside the onlending arrangement will become NPA even if one of the credit facilities granted to the same borrower becomes NPA. 53

7.1.6 Advances against Term Deposits, NSCs, KVP/IVP, etc.: Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and life policies need not be treated as NPAs. Advances against gold ornaments, government securities and all other securities are not covered by this exemption.

7.1.7 Loans with moratorium for payment of interest In the case of bank finance given for industrial projects or for agricultural plantations etc. where moratorium is available for payment of interest, payment of interest becomes 'due' only after the moratorium or gestation period is over. Therefore, such amounts of interest do not become overdue and hence NPA, with reference to the date of debit of interest. They become overdue after due date for payment of interest, if uncollected. In the case of housing loan or similar advances granted to staff members where interest is payable after recovery of principal, interest need not be considered as overdue from the first quarter onwards. Such loans/advances should be classified as NPA only when there is a default in repayment of installment of principal or payment of interest on the respective due dates.

7.1.8 Agricultural advances In respect of advances granted for agricultural purpose where interest and/or installment of principal remains unpaid after it has become past due for two harvest seasons but for a period not exceeding two half years, such an advance should be treated as NPA. The above norms should be made applicable to all direct agricultural advances as listed at items 1.1, 1.1.2 (i) to (vii), 1.1.2 (viii)(a)(1) and 1.1.2 (viii)(b)(1) of Master Circular on lending to priority sector No. RPCD. PLAN. BC. 12/04.09.01/ 2001- 2002 dated 1 August 2001. An extract of the list of these items is furnished in the Annexure II. In respect of agricultural loans, other than those specified above, identification of NPAs would be done on the same basis as non-agricultural advances which, at present, are the 180 days delinquency norm. 54

Where natural calamities impair the repaying capacity of agricultural borrowers, banks may decide on their own as a relief measure conversion of the short-term production loan into a term loan or re-schedulement of the repayment period; and the sanctioning of fresh short-term loan, subject to various guidelines contained in RBI circulars RPCD.No.PLFS.BC.128/05.04.02/97-98 dated 20.06.98 and RPCD.No.PLFS.BC.9/05.01.04/98-99 dated 21.07.98.

In such cases of conversion or re-schedulement, the term loan as well as fresh short-term loan may be treated as current dues and need not be classified as NPA. The asset classification of these loans would thereafter be governed by the revised terms & conditions and would be treated as NPA if interest and/or installment of principal remains unpaid, for two harvest seasons but for a period not exceeding two half years.

7.1.9.Government guaranteed advances:

The credit facilities backed by guarantee of the Central Government though overdue may be treated as NPA only when the Government repudiates its guarantee when invoked. This exemption from classification of Government guaranteed advances as NPA is not for the purpose of recognition of income. With effect from 1st April 2000, advances sanctioned against State Government guarantees should be classified as NPA in the normal course, if the guarantee is invoked and remains in default for more than two quarters. With effect from March 31, 2001 the period of default is revised as more than 180 days.

7.2.1.Take-out Finance: Takeout finance is the product emerging in the context of the funding of long-term infrastructure projects. Under this arrangement, the institution/the bank financing infrastructure projects will have an arrangement with any financial institution for transferring to the latter the outstanding in respect of such financing in their books on a predetermined basis. In view of the time-lag involved in taking-over, the possibility of a default in the meantime cannot be ruled out. The norms of asset classification will have to be followed by the concerned bank/financial institution in whose books the account stands as balance sheet item as on the relevant date. If the lending 55

institution observes that the asset has turned NPA on the basis of the record of recovery, it should be classified accordingly. The lending institution should not recognize income on accrual basis and account for the same only when it is paid by the borrower/ taking over institution (if the arrangement so provides). The lending institution should also make provisions against any asset turning into NPA pending its takeover by taking over institution. As and when the asset is taken over by the taking over institution, the corresponding provisions could be reversed. However, the taking over institution, on taking over such assets, should make provisions treating the account as NPA from the actual date of it becoming NPA even though the account was not in its books as on that date.

7.2.2. Post-shipment Supplier's Credit In respect of post-shipment credit extended by the banks covering export of goods to countries for which the ECGC’s cover is available, EXIM Bank has introduced a guarantee-cumrefinance programme whereby, in the event of default, EXIM Bank will pay the guaranteed amount to the bank within a period of 30 days from the day the bank invokes the guarantee after the exporter has filed claim with ECGC. Accordingly, to the extent payment has been received from the EXIM Bank, the advance may not be treated as a non-performing asset for asset classification and provisioning purposes.

7.2.3 Export Project Finance: In respect of export project finance, there could be instances where the actual importer has paid the dues to the bank abroad but the bank in turn is unable to remit the amount due to political developments such as war, strife, UN embargo, etc. In such cases, where the lending bank is able to establish through documentary evidence that the importer has cleared the dues in full by depositing the amount in the bank abroad before it turned into NPA in the Books of the bank, but the importer's country is not allowing the funds to be remitted 56

due to political or other reasons, the asset classification may be made after a period of one year from the date the amount was deposited by the importer in the bank abroad.

7.2.4. Advances under rehabilitation approved by BIFR/ TLI: Banks are not permitted to upgrade the classification of any advance in respect of which the terms have been re-negotiated unless the package of re-negotiated terms has worked satisfactorily for a period of one year. While the existing credit facilities sanctioned to a unit under rehabilitation packages approved by BIFR/term lending institutions will continue to be classified as sub-standard or doubtful as the case may be, in respect of additional facilities sanctioned under the rehabilitation packages, the Income Recognition, Asset Classification norms will become applicable after a period of one year from the date of disbursement.

7.2.5. ROLE OF ARCIL:This empowerment encouraged the three major players in Indian banking system, namely, State Bank of India (SBI), ICICI Bank Limited (ICICI) and IDBI Bank Limited (IDBI) to come together to set-up the first ARC. Arcil was incorporated as a public limited company on February 11, 2002 and obtained its certificate of commencement of business on May 7, 2003. In pursuance of Section 3 of the Securitization Act 2002, it holds a certificate of registration dated August 29, 2003, issued by the Reserve Bank of India (RBI) and operates under powers conferred under the Securitization Act, 2002. Arcil is also a "financial institution" within the meaning of Section 2 (h) (ia) of the Recovery of Debts due to Banks and Financial Institutions Act, 1993 (the "DRT Act"). Arcil is the first ARC in the country to commence business of resolution of non-performing assets (NPAs) upon acquisition from Indian banks and financial institutions. As the first ARC, Arcil has played a pioneering role in setting standards for the industry in India.

57

➢

Unlocking capital for the banking system and the economy

The primary objective of Arcil is to expedite recovery of the amounts locked in NPAs of lenders and thereby recycling capital. Arcil thus, provides relief to the banking system by managing NPAs and help them concentrate on core banking activities thereby enhancing shareholders value. ➢

Creating a vibrant market for distressed debt assets / securities in India offering a trading platform for Lenders

Arcil has made successful efforts in funneling investment from both from domestic and international players for funding these acquisitions of distressed assets, followed by showcasing them to prospective buyers. This has initiated creation of a secondary market of distressed assets in the country besides hastening their resolution. The efforts of Arcil would lead the country’s distressed debt market to international standards. ➢

To evolve and create significant capacity in the system for quicker resolution of NPAs by deploying the assets optimally

With a view to achieving high delivery capabilities for resolution, Arcil has put in place a structure aimed at outsourcing the various sub-functions of resolution to specialized agencies, wherever applicable under the provision of the Securitization Act, 2002. Arcil has also encourage, groomed and developed many such agencies to enhance its capacity in line with the growth of its activity.

58

CHAPTER-8 Data analysis and interpretation

7.

ANALYSIS

For the purpose of analysis and comparison between Public and private sector banks, We have taken five banks from both sectors to compare the non-performing assets of banks. For understanding we further bifurcate the non-performing assets in priority sector and non-priority sector, gross NPA and net NPA in percentage as well as in rupees, deposit – investment – advances. Further we also analysis on the basis of Deposit – Investment – Advances to get the clear view where the bank stands in the competitive market. At the end of March 2008, in private 59

sector ICICI Bank is the highest deposit-investment-advances figure in rupees crore, second is HDFC Bank and KOTAK Bank has least figure. In public sector banks Punjab National Bank has the highest deposit investment- advances but when we look at the graph we can see that the Bank of Baroda and Bank of India are almost the similar in numbers and Dena Bank is stands last in public sector bank. When we compare the private sector banks with public sector banks, we can understand the more number of people prefer to choose public sector banks for depositinvestment.

DEPOSIT-INVESTMENT-ADVANCES (RS.CRORE) of both sector banks and comparison among them, year 2008-09.

Private Sector Banks:(Rs in crore)

BANK AXIS HDFC

DEPOSIT 87626 100769

INVESTMENT 33705 49394

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ADVANCES 59661 63427

ICICI KOTAK INDUSIND

244431 16424 19037

111454 9142 6630

225616 15552 12795

TOTAL

468287

210325

377051

Analysis:-

From the above figure we can see that the ICICI Bank deposit-investment-advances are quite high than other banks like HDFC,AXIS,INDUSIND,KOTAK

Public Sector Banks:-

BANK BOB BOI DENA PNB UBI TOTAL

DEPOSIT 152034 150012 33943 166457 103859 606305

INVESTMENT 43870 41803 10282 53992 33823 183770

Analysis:-

ADVANCES 106701 113476 23024 119502 74348 437051

In public sector Punjab National Bank depositinvestment-advances are comparatively quite high rather than Bank of Baroda, Bank of India, United bank of India and Dena Bank.

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Comparison between ICICI BANK AND PUNJAB NATIONAL BANK in term of

deposit-investment-advances:BANK

DEPOSIT

INVESTMENT

ADVANCES

ICICI BANK

244431

111454

225616

PNB

166457

53992

119502

Analysis: - Here we

have compared between ICICI BANK AND PUNJAB

deposit-investment-advances. From the above figure we can see that ICICI bank deposit and advances are quite higher than Punjab National Bank. But in case of Investment ICICI Bank investment amount is doubled than Punjab National Bank amount. NATIONAL BANK in term of

Gross NPA and Net NPA:62

There are two concepts related to non-performing assets a) gross and b) net. Gross refers to all NPAs on a bank’s balance sheet irrespective of the provisions made. It consists of all the non-standard assets, viz. Substandard, doubtful, and loss assets. A loan asset is classified as ‘ substandard” if it remains NPA up to a period of 18 months; “ doubtful” if it remains NPA for more than 18 months; and loss, without any waiting period, where the dues are considered not collectible or marginally collectible. Net NPA is gross NPA less provisions. Since in India, bank balance sheets contains a huge amount of NPAs and the process of recovery and write off of loans is very time consuming, the provisions the banks have to make against the NPA according to the central bank guidelines, are quite significant. Here, we can see that there are huge differences between gross and net NPA. While gross NPA reflects the quality of the loans made by banks, net NPA shows the actual burden of banks. The requirements for provisions are:  100% for loss assets  100% of the unsecured portion plus 20-50% of the secured portion, depending on the period for which the account has remained in the doubtful category  10% general provision on the outstanding balance under the substandard category. Here, there are gross and net NPA data for 2007-08 and 200809 we taken for comparison among banks. These data are NPA AS PERCENTAGE OF TOTAL ASSETS. As we discuss earlier that gross NPA reflects the quality of the loans made by banks. Among all the ten banks Dena Banks has highest gross NPA as a percentage of total assets in the year 2007-08 and also net NPA. Punjab National Bank shows huge difference between gross and net NPA. There is an almost same figure between BOI and BOB.

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Gross NPA and Net NPA Of different Public Sector banks in the year 2007-08 BANK

GROSS NPA

NET NPA

BOB

1.46

0.35

BOI

1.48

0.45

DENA

2.37

1.16

PNB

2.09

0.45

UBI

1.82

0.59

Gross NPA and Net NPA Of different Public Sector banks in the year 2008-09 BANK

GROSS NPA

NET NPA

BOB

1.10

0.27

BOI

1.08

0.33

DENA

1.48

0.56

PNB

1.67

0.38

UBI

1.34

0.10

Gross NPA and Net NPA Of different Private Sector banks in the year 2007-08 BANK

GROSS NPA

NET NPA

AXIS

0.57

0.36

HDFC

0.72

0.22

ICICI

1.20

0.58

KOTAK

1.39

1.09

INDUSIND

1.64

1.31

Gross NPA and Net NPA Of different Private Sector banks in the year 2008-09 64

BANK

GROSS NPA

NET NPA

AXIS

0.45

0.23

HDFC

0.68

0.22

ICICI

1.90

0.87

KOTAK

1.55

0.98

INDUSIND

1.69

1.25

Comparison of GROSS NPA with Public and Private sectors banks for the year 2007-08 Comparison of GROSS NPA with all banks for the year 200708. The growing NPAs affect the health of banks, profitability and efficiency. In the long run, it eats up the net worth of the banks. We can say that NPA is not a healthy sign for financial institutions. Here we take all the ten banks gross NPA together for better understanding. Average of these ten banks gross NPAs is 1.29 as percentage of total assets. So if we compare in private sector banks AXIS and HDFC Bank are below average of all banks and in public sector BOB and BOI. Average of these five private sector banks gross NPA is 1.25 and average of public sector banks is 1.33. Which is higher in compare of private sector banks.

COMPARISON OF NET NPA WITH PUBLIC AND PRIVATE SECTORS BANKS FOR THE YEAR 2007-08 Comparison of NET NPA with all banks for the year 2007-08. Average of these ten bank’s net NPA is 0.56. And in the public sector banks all these five banks are below this. But in private sector banks there are three banks are above average. The difference between private and public banks average is also vast. Private sector banks net NPA average is 0.71 and in public sector banks it is 0.41 as percentage of total assets. As we know that net NPA shows actual burden of banks. IndusInd bank has highest net NPA figure and HDFC Bank has lowest in comparison.

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PRIORITY –NON PRIORITY SECTOR When we further bifurcate NPA in priority sector and Non priority sector. Agriculture + small + others are priority sector. In private sector ICICI Bank has the highest NPA with compare to other private sector banks. Around 72% of NPA in priority sector and around 78% in non-priority sector. We can see that in private sector banks have more NPA in non-priority sector than priority sector. BANK

AGRI

SMALL

OTHERS

PRIORITY

NON-PRIORITY

(1)

(2)

(3)

SECTOR

AXIS

109.12

14.76

86.71

( 1+2+3 ) 210.59

275.06

HDFC

36.12

110.56

47.70

194.41

709.23

ICICI

981.85

23.35

354.13

1359.34

6211.12

KOTAK

10.00

33.84

4.04

47.87

405.20

INDUSIND

30.44

3.18

30.02

63.64

328.67

TOTAL

1167.53

185.69

522.60

1875.85

7929.28

When we talk about public sector banks they are more in priority sector and they give advanced to weaker sector or industries. Public sector banks give more loans to Agriculture, small scale and others units and as a result we see that there are more number of NPA in public sector banks than private sector banks. BOB given more advanced to priority sector in 2008-09 than other four banks .

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BANK

PRIORITY SECTOR

NPA

BOB

(ADVANCED RS.CRORE ) 5469

350

BOI

3269

325

DENA

1160

106

PNB

3772

443

UBI

1924

197

But when there are comparison between private bank and public sector bank still ICICI Bank has more NPA in both priority and non-priority sector with the comparison of public sector banks. Large NPA in ICICI Bank because the strategy of bank that risk-reward attitude and initiative in each sector. Above we also discuss that ICICI Bank has highest depositinvestment-advance than other banks.

Now, when we compare the all public sector and private sector banks on priority and non-priority sector the figures are really shocking. Because in compare of private sector banks, public sector banks numbers are very large.

SECTOR PRIORITY PUBLIC NON PRT TOTAL

PUBLIC SECTOR 2007-08 2008-09 22954 490 15158 38602

25287 299 14163 39749

NEW PRIVATE 2007-08 2008-09 1468 3 4800 6271

2080 0 8339 10419

Here, there are huge differences between private and public sector banks NPA. There is increase in new private sector banks NPA of Rs.4148 cr in 2008-09 which is almost 66% rise than previous year. In public sector banks the numbers are not increased like private sector banks.

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ANNEXURE-I REPORTING FORMAT FOR NPA – GROSS AND NET NPA

Name of the Bank: Position as on……… PARTICULARS 1) Gross Advanced * 2) Gross NPA * 3) Gross NPA as %age of Gross Advanced 4) Total deduction( a+b+c+d ) ( a ) Balance in interest suspense a/c ** ( b ) DICGC/ECGC claims received and held pending

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adjustment ( c ) part payment received and kept in suspense a/c ( d ) Total provision held *** 5) Net advanced ( 1-4 ) 6) Net NPA ( 2-4 ) 7) Net NPA as a %age of Net Advance 8) Net NPA as a %age of Net Advance

*excluding Technical write-off of Rs.________crore. **Banks which do not maintain an interest suspense a/c to park the accrued interest on NPAs may furnish the amount of interest receivable on NPAs. ***Excluding amount of Technical write-off (Rs.______crore) and provision on standard assets. (Rs._____crore).

Bibliography Journals and magazines • Economic and political weekly, October 16, 2004, CARLTON PEREIRA, Page 4602-4604 “INVESTING IN NPAs”. •

Chartered Financial Analyst, August 2004, B P Dhaka, Page 58-62; “SARFAESI ACT: THE DIAGNOSIS”.

•

The chartered Accountant, February 2005, Raj Kumar S Adukia, Page NO. 978-985; “SECURITISATION – AN OVERVIEW”

•

Treasury Management, December 2004, MPM Vinay Kumar, Page 62-65; “SECURITISATION : ISSUES AND PERSPECTIVES”.

•

Chartered Secretary, Feburary 2003, V S Datey, Page 128135; “SECURITISATION, RECONSTRUCTION AND ENFORCEMENT OF SECURITY INTEREST”. 69

Websites:•

http://www.indiastat.com/banksandfinancialinstitutions/3/perform ance/16063/nonperformingassetsnpas/377761/stats.aspx

•

http://www.bankcapitalgroup.net/services-non-performingassets.php

•

http://rituparnodas.blogspot.com/2009/01/npa-management.html

•

http://www.finanssivalvonta.fi/en/Statistics/Credit_market/Nonper forming_assets/Pages/Default.aspx

http://findarticles.com/p/articles/mi_hb5562/is_200905/ai_n3189646 1/

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