Rural Banking

Assignment 1 Submitted to

Prof. KK Ray

Submitted By: Deepak Kumar Shashi Kr. Yadav VijayaBharthi. A

NPA Management of Commercial Banks in India

Contents
Introduction .......................................................................................................................... 2 What is NPA? ....................................................................................................................... 2 RBIs Norm for NPA ............................................................................................................ 2 Identification of an account as NPA- RBI Guidelines ............................................................ 2 Term loans ........................................................................................................................ 3 Over draft/cash credit ........................................................................................................ 3 Bills Purchased/Discounted ............................................................................................... 3 Agricultural advances .................................................................................................... 3 Other Credit facility .......................................................................................................... 4 Accounts with temporary deficiencies ............................................................................... 4 Charging of Interest at monthly rests ................................................................................. 4 Asset Classification ............................................................................................................... 4 Standard Assets................................................................................................................. 4 Sub-standard Assets .......................................................................................................... 5 Doubtful Assets ................................................................................................................. 5 Loss Assets ........................................................................................................................ 5 NPAs in Indian Banking Industry .......................................................................................... 5 NPAs in Indian Banks vis--vis other countries ................................................................. 5 NPA Management Policy at Various Indian Banks ................................................................ 6 State Bank of India ............................................................................................................ 6 Canara Bank ...................................................................................................................... 7 Bank of India .................................................................................................................... 7 Health Code System and Asset Classification ................................................................ 7 Impact of NPA ...................................................................................................................... 8 Profitability ....................................................................................................................... 8 Liquidity ........................................................................................................................... 8 Reasons for NPA................................................................................................................... 8 Internal Factors: ................................................................................................................ 8 External Factors: ............................................................................................................... 8 Preventive Measures for NPA ............................................................................................... 9 Management of NPA............................................................................................................. 9 Conclusion .......................................................................................................................... 11

NPA Management of Commercial Banks in India

Introduction
Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. A high level of NPAs suggests high probability of a large number of credit defaults that affect the profitability and net-worth of banks and also erodes the value of the asset. The problem of NPAs is not only affecting the banks but also the whole economy. The paper deals with understanding the concept of NPAs, its magnitude and major causes for an account becoming non-performing and also strategies for reducing NPAs. Today the Net NPAs of Indian PSBs (which account for around three-fourths of the total assets of Indian banking industry) are as low as 0.72 percent and gross NPAs are at 2.5 percent. However, Nitsure (2007) contends that once there is a slowdown in private expenditure and corporate earnings growth, companies on these banks books will not be in a position to service their debts on time and there is a strong likelihood of generation of new NPAs. Moreover, he also suggests that with rising interest rates in the government bond market, the banks treasury incomes have declined considerably. So banks will not have enough profits to make provisions for NPAs. What is NPA? An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. A Non-performing asset is a debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The nonperforming asset is therefore not yielding any income to the lender in the form of principal and interest payments. It is defined as a credit facility in respect of which the interest and/or installment of principal has remained past due for a specified period of time.

RBIs Norm for NPA An asset becomes NPA when it ceases to generate income for the bank. This would mean that interest, which is debited to borrowers account, has to be realised by the bank. An account has to be classified as NPA on the basis of record of recovery rather than security charged in favour of the bank in respect of such account. Thus, an account of a borrower may become NPA if interest charged to that particular borrower is not realised despite the ac-count being fully secured

Identification of an account as NPA- RBI Guidelines RBI has laid down various norms for classifying various types of advances as NPA. The following are the classifications. 2

NPA Management of Commercial Banks in India

Term loans
Interest and/or installment of principal remain overdue for a period of more than more than 90days.

Over draft/cash credit

If an account remains out of order, it would become an NPA. For this norm an account will be considered to be in out of order if i) ii) The outstanding balance remains continuously in excess of the sanctioned limit/drawing power for 90 days or more, or Even if the outstanding in the account is less than the sanctioned limit/drawing power, there are no credits in the account continuously for 90 days as on the date of the Balance sheet, or Credits in the account are not sufficient to cover interest debited during the same period.

iii)

Bills Purchased/Discounted
If the bills purchased or discounted remains overdue for a period of more than 90 days from its due date.

Agricultural advances A loan granted for Short duration crops will be termed as NPA, if the installment for principal f interest will thereon remains overdue for two crop seasons. ii. Long duration crops will be treated as NPA, if the installment of principal thereon remains overdue for one crop season. For the purpose of these guidelines long duration crops would be crops with crop season longer than one year abs crops which are not long duration crops would be treated as short duration crops. The crop season for each crop, which means the period up to harvesting of the crops raised, would be as determined by the State Level Bankers' Committee in each state. Depending upon the duration of crops raised by an agriculturist, the above NPA norms would also be made applicable to agricultural term loans availed of by him. In respect of agricultural loans, other than those specified in the Annex 1 and term loans given to nonagriculturists, identification of NPAs would be done on the same basis as non-agricultural advances, which, at present, is the 90 days delinquency norm. Banks should ensure that while granting loans and advances, realistic repayment schedules are fixed on the basis of cash flows / fluidity with the borrowers. i.

NPA Management of Commercial Banks in India

Other Credit facility

In case of other credit facility, if the amount to be received remains overdue for more than 90 days, then the account will be classified as NPA.

Accounts with temporary deficiencies

Even though criteria laid down for identification of an account as NPA are objective, an account should not be classified as NPA if the deficiencies like non-submission of stock statement, non-renewal of facility in the account are temporary in nature.

Charging of Interest at monthly rests

Banks should charge interest at monthly rests in the context of adoption of 90 days norm for recognition of loan impairment w.e.f. from the year ended March 31, 2004 and consequential need for close monitoring of borrowers' accounts. However, the date of classification of an advance as NPA should not be changed on account of charging of interest at monthly basis. The existing practice of charging / compounding of interest on agricultural advances would be linked to crop seasons and the instructions regarding charging of interest on monthly rests shall not be applicable to agricultural advances. While compounding interest at monthly rests effective from April 1, 2003, banks should ensure that in respect of advances where administered interest rates are applicable, they should re-align the rates suitably keeping in view the minimum lending rate charged by the bank (in view of the freedom given to them for fixing lending rates) so that they comply with the same. In all other cases also, banks should ensure that the effective rate does not go up merely on account of the switch over to the system of charging interest on monthly rests. Banks should take into consideration due date/s fixed on the basis of fluidity with borrowers and harvesting / marketing season while charging interest and compound the same if the loan / instalment becomes overdue in respect of short duration crops and allied agricultural activities.

Asset Classification
Banks should classify their assets into the following broad groups, viz. (i) Standard Assets (ii) Sub-standard Assets (iii) Doubtful Assets (iv) Loss Assets

Standard Assets
Standard Asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset should not be an NPA.

NPA Management of Commercial Banks in India

Sub-standard Assets
With effect from March 31, 2005 an asset would be classified as sub-standard if it remained NPA for a period less than or equal to 12 months. In such cases, the current net worth of the borrowers / guarantors or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full. In other words, such assets will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. ii. An asset where the terms of the loan agreement regarding interest and principal have been re-negotiated or rescheduled after commencement of production, should be classified as substandard and should remain in such category for at least 12 months of satisfactory performance under the re-negotiated or rescheduled terms. In other words, the classification of an asset should not be upgraded merely as a result of rescheduling, unless there is satisfactory compliance of this condition. i.

Doubtful Assets
With effect from March 31, 2005, an asset is required to be classified as doubtful, if it has remained NPA for more than 12 months. For Tier I banks, the 12-month period of classification of a substandard asset in doubtful category is effective from April 1, 2009. As in the case of sub-standard assets, rescheduling does not entitle the bank to upgrade the quality of an advance automatically. A loan classified as doubtful has all the weaknesses inherent as that 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.

Loss Assets
Loss asset is one where loss has been identified by the bank or internal or external auditors or by the Co-operation Department or by the Reserve Bank of India inspection but the amount has not been written off, wholly or partly. In other words, such an asset is 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.

NPAs in Indian Banking Industry

NPAs in Indian Banks vis--vis other countries
In Comparison of the problem loan levels in the Indian Banking system vis--vis those other countries, particularly those in developed economies, is often made, more so in the context of the opening up of our financial sector. The data in respect of NPAs level of banking system available for countries like USA, Japan, Hongkong, Korea, Taiwan and Malaysia reveal that it ranged from 1% to 8.1% during 1993-94, 0.9% to 5.5% during 199495 and 0.85% to 3.9% during 1995-96 as against 23.6%, 19.5% and 17.3% respectively for Indian banks during these years.

NPA Management of Commercial Banks in India Notwithstanding this, some features relating to the NPA reporting/evaluation practices in other countries vis--vis those in our country need, however, to be considered before reaching to any conclusion on the level of non-performing advances. In some countries, all or bulk of banks' provisions are general provisions and identified losses are written off at an early stage. Banks in these countries carry very little NPAs in their Balance Sheets. The recovery measures are also expeditious in view of stringent bankruptcy and foreclosure laws. The concept of Gross NPA and Net NPA is not in vogue in these countries. In Indian banking, due to the time lag involved in the recovery process and the detailed safeguards/procedures involved before write off could be effected, banks even after making provisions for the advances considered irrecoverable, continue to hold such advances in their books which is termed as Gross NPA together with the provisions. The provision adjusted NPAs in Indian banking segment i.e. Net NPAs, constitute only 8.2% of the net advances of the banks as on 31March 1998 which no doubt are high by international standard but are not so alarming as Gross NPAs project.

NPA Management Policy at Various Indian Banks

Most of the Banks (especially government controlled) started unveiling new policy, around year 1998 to 2000 and guidelines for the effective management of Non-Performing Assets in conformity of the guidelines issued by Reserve Bank of India (RBI). Describing below some of the intervention steps undertaken by Various Banks:

State Bank of India

The State Bank of India on August 11, 1998 unveiled a new policy before the Parliamentary standing committee on finance a comprehensive NPA management policy which involves proactive initiatives to prevent the generation of fresh non-performing assets (NPAs). The aim of the policy is to contain net NPAs to less than 5 per cent of the bank's total loan assets in conformity with the international standard. The policy basically concerns itself with the management of NPAs in the banks' domestic offices. The policy lays down a broad approach, including critical parameters to be taken into account, for recovery of loans through compromise settlements. Regarding compromise settlements, the bank has said that it is not possible to lay down precise guidelines which can be followed uniformly in all compromise offers as each offer is unique in the context of circumstances necessitating its consideration as recovery option. However, the policy said that an initial deposit of at least 5 per cent of the outstanding will be taken from the borrower as evidence of the borrower's intention to pursue the compromise settlement with the bank. It will be the endeavor of the bank to get the entire compromise amount paid up in a lump sum. The accounts exhibiting early warning signals of potentials credit risks will include transaction-related signals like persistent irregularity in accounts, defaults in repayment obligations, development of LC liabilities, invocation of guarantees, operating losses and activity-related physical signals like rejection of products, some of the machines lying idle, number of shifts decreasing. The warning indicators generally emanate from the unit's

NPA Management of Commercial Banks in India financial problems, operation problems, market-related problems and problems arising out of regulatory changes.

Canara Bank
On January 03, 2000 Canara bank has taken up a series of initiatives especially to improve the quality of its assets and also to contain fresh accruals of non-performing assets (NPAs). These measures include inter-face meetings with Circle Offices and setting of targets, recovery meets for compromise settlements and recovery camps at branches. All these measures adopted have resulted in a significant decline in the net NPA ratio from 7.52 per cent on March 31, 1998 to 7.09 per cent by the end of last fiscal year. With a progressive decline in the net NPAs ratio, the bank has aimed at containing the level of net NPAs to below four per cent in the next few years. Towards this, it has been embarking upon more and more innovative measures, which would help it right from the stage of making credit decisions to regularly monitoring them on an ongoing basis to effectively avoid slippages.

Bank of India
Health Code System and Asset Classification Begin with June 1982; Bank of India introduced the system of classifying the credit portfolio in terms of various health codes. Subsequently, in the year 1985, when the Reserve Bank of India introduced the health code system in the entire banking industry. Branches are advised to grade the borrowal accounts on an ongoing basis into health codes. Some of the Guidelines for classifying advances as per health code system: Code 1: satisfactory This category covers all borrowers where: a) Conduct of the account is satisfactory. b) All terms and conditions (like punctual submission of stock statements, balance sheets for annual review, execution of annual acknowledgement of debt and security etc) are complied with. c) Accounts of the borrower are in order. d) The safety of the accounts is not in doubt. Code 2: Irregular a) This category covers those accounts where the safety of the advance is not suspected, though there may be occasional irregularities. The accounts are overdrawn beyond the drawing power or the sanctioned limit for a temporary period. b) Instalments in respect of term loans overdue for less than 6 months or under deferred payment guarantee, if overdue for less than 3 months. c) Some of the bills (not exceeding 10%-15% of the total outstanding in the bills purchased or discounted, account of the borrower) are overdue for payment by less than 3 months and/or refund in respect of unpaid bills is not forthcoming immediately 7

NPA Management of Commercial Banks in India

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 cost also as that much of profit invested in some return earning project/asset. So NPA doesnt affect current profit but also future stream of profit, which may lead to loss of some long-term beneficial opportunity.

Liquidity
Money is getting blocked, decreased profit lead to lack of enough cash at hand which lead to borrowing money for short 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.

Reasons for NPA

Reasons can be divided in to two broad categories: a) Internal Factor b) External Factor

Internal Factors:
Internal Factors are those, which are internal to the bank and are controllable by banks i. ii. iii. iv. v. vi. Poor lending decision: Non-Compliance to lending norms: Lack of post credit supervision: Failure to appreciate good payers: Excessive overdraft lending: Non Transparent accounting policy:

External Factors:
External factors are those, which are external to banks they are not controllable by banks. I. II. III. IV. V. VI. VII. VIII. Socio political pressure: Change in industry environment: Endangers macroeconomic disturbances Natural calamities Industrial sickness Diversion of funds and willful defaults Time/ cost overrun in project implementation Labour problems of borrowed firm 8

NPA Management of Commercial Banks in India IX. X. XI. Business failure Inefficient management Obsolete technology

Preventive Measures for NPA

I. II. III. IV. V. VI. Early recognition of Problem Identifying Borrowers with Genuine Intent Timeliness and Adequacy of response Focus on Cash Flows Management Effectiveness Multiple Financing

Management of NPA
According to RBI annual report,2005-2006,banks in India have been able to contain their NPAs to just two per cent to their net advances in spite of adopting 90 days delinquency norms. This has been possible because of treasury profits by banks .Recovery and management of NPAs has significantly strengthened the lenders ability to enforce its right to collateral under the securitization and reconstruction of financial assets Enforcement of security interest (SARFAESI) ACT, 2002.The corporate debt restructuring (CDR) system has also emerged as a time bound and transparent mechanism for arriving at a borrower. The credit information companies Act2005, enables sharing of credit information which help in reducing transactional costs of banks in extending credit to small and medium borrowers which again translates into lower NPA.

NPA Management of Commercial Banks in India

Figure 1 Non Performing Assets of Public Sector Banks

Figure 2 Sector-Wise Non-Performing Assets

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NPA Management of Commercial Banks in India

Conclusion
The Indian banking sector is the important service sector that helps the people of the India to achieve the socioeconomic 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 only problem that the Public Sector Banks are facing today is the problem of nonperforming assets. 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 fund. 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 the banks 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.

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NPA Management of Commercial Banks in India References http://www.business-standard.com/india/news/npa-management-biggest-challengefor-banks-in-2009/344691/ http://www.rbi.org.in/scripts/BS_CircularIndexDisplay.aspx?Id=2904 http://www.scribd.com/doc/8817767/A-REPORT-ON-NPA-IN-BANKING www.economywatch.com www.statebankofindia.com www.canarabank.in http://www.bankofindia.com/homepage1.aspx MANAGEMENT OF NON-PERFORMING ASSETS IN PUBLIC SECTOR BANKS:EVIDENCE FROM INDIA

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