Non-Performing Assets in Indian Banks

By

B. Sathish Kumar
Faculty MBA
V.L.B. Janakiammal College of Engineering & Technology
Coimbatore
E-mail: sathish_inbox@yahoo.co.in

In liberalizing economy banking and financial sector get high priority. Indian banking sector of having a
serious problem due non performing. The financial reforms have helped largely to clean NPA was around
Rs. 52,000 crores in the year 2004. The earning capacity and profitability of the bank are highly affected
due to this

NPA is defined as an advance for which interest or repayment of principal or both remain out standing
for a period of more than two quarters. The level of NPA act as an indicator showing the bankers credit
risks and efficiency of allocation of resource.

Reasons:

Various studies have been conducted to analysis the reasons for NPA. What ever may be complete
elimination of NPA is impossible. The reasons may be widely classified in two:

(1) Over hang component

(2) Incremental component

Over hang component is due to the environment reasons, business cycle etc.

Incremental component may be due to internal bank management, credit policy, terms of credit etc.

Asset Classification :

The RBI has issued guidelines to banks for classification of assets into four categories.

1. Standard assets:
These are loans which do not have any problem are less risk.

2. Substandard assets:
These are assets which come under the category of NPA for a period of less then 12 months.

3. Doubtful assets:
These are NPA exceeding 12 months

4. Loss assets:
These NPA which are identified as unreliable by internal inspector of bank or auditors or by RBI.

The classification of assets of scheduled commercial bank.

Table 1 (Amount Rs.

crores)

Assets 2001 2002 2003 2004

494716 609972 709260 837130
Standard assets
(88.6) (89.6) (91.2) (92.8)
18206 21382 20078 21026
Sub standard assets
(3.3) (3.1) (2.6) (2.3)
37756 41201 39731 36247
Doubtful assets
(6.8) (6.1) (5.1) (4.36)
8001 8370 8971 7625
Loss assets
(1.4) (1.2) (1.2) (0.8)
63963 70953 68780 902027
Total NPA
(11.4) (10.4) (8.8) (100)

Income recognition and provisioning

Income from NPA is not recognized on accrued basic but is booked as income only when, it is actually
received. RBI has also tightened red the provisions norms against asset classification. It ranges from
0.25% to 100% from standard asset to loss asset respectively.

Gross and net NPA of different sector of bank

Table 2 (end of March 31) (in %)

category Gross NPA/ Gross Advance

2001 2002 2003 2004
Public sector bank 12.37 11.09 9.36 7.79
Private sector 8.37 9.64 8.07 5.84
Foreign bank 6.84 5.38 5.25 4.62

Table 3 (end of March 31) (in %)

category Net NPA / Net Advance

2001 2002 2003 2004
Public sector bank 6.74 5.82 4.53 2.98
Private sector 2.27 2.49 2.32 1.32
Foreign bank 1.82 1.89 1.76 1.49

The table II and III shows that the percentage of gross NPA/ gross advance and net NPA/ net advance
are in a decreasing trend. This shows the sign of efficiency in public and private sector bamks.but still if
compared to foreign banks Indian private sector and public sector banks have a higher NPA.

Management of NPA

The table II&III shows that during initial sage the percentage of NPA was higher. This was due to show
ineffective recovery of bank credit, lacuna in credit recovery system, inadequate legal provision etc.
Various steps have been taken by the government to recover and reduce NPAs. Some of them are.

1. One time settlement / compromise scheme

2. Lok adalats
3. Debt Recovery Tribunals
4. Securitization and reconstruction of financial assets and enforcement of Security Interest Act 2002.
5. Corporate Reconstruction Companies
6. credit information on defaulters and role of credit information bureaus

CONCLUSION

The Indian banking sector is facing a serious problem of NPA. The extent of NPA is comparatively higher
in public sectors banks. (Table II&III). To improve the efficiency and profitability, the NPA has to be
scheduled. Various steps have been taken by government to reduce the NPA. It is highly impossible to
have zero percentage NPA. But at least Indian banks can try competing with foreign banks to maintain
international standard.

B. Sathish Kumar
Faculty MBA
V.L.B. Janakiammal College of Engineering & Technology
Coimbatore
E-mail: sathish_inbox@yahoo.co.in

Source: E-mail November 8, 2005

Reserve Bank Guidelines on purchase/ sale of Non
Performing Financial Assets

Scope

1. These guidelines would be applicable to banks, FIs and NBFCs purchasing/ selling non
performing financial assets, from/ to other banks/FIs/NBFCs (excluding securitisation companies/
reconstruction companies).

2. A financial asset, including assets under multiple/consortium banking arrangements, would be

eligible for purchase/sale in terms of these guidelines if it is a non-performing asset/non
performing investment in the books of the selling bank.

3. The reference to 'bank' in the guidelines would include financial institutions and NBFCs.

Structure

4. The guidelines to be followed by banks purchasing/ selling non-performing financial assets

from / to other banks are given below. The guidelines have been grouped under the following
headings:

i. Procedure for purchase/ sale of non performing financial assets by banks, including valuation
and pricing aspects.

ii. Prudential norms, in the following areas, for banks for purchase/ sale of non performing
financial assets:

a. Asset classification norms

b. Provisioning norms
c. Accounting of recoveries
d. Capital adequacy norms
e. Exposure norms

iii. Disclosure requirements

5. Procedure for purchase/ sale of non performing financial assets, including valuation and pricing
aspects

i. A bank which is purchasing/ selling non-performing financial assets should ensure that the
purchase/ sale is conducted in accordance with a policy approved by the Board. The Board shall
lay down policies and guidelines covering, inter alia,

a. Non performing financial assets that may be purchased/ sold;

b. Norms and procedure for purchase/ sale of such financial assets;
c. Valuation procedure to be followed to ensure that the economic value of financial assets is
reasonably estimated based on the estimated cash flows arising out of repayments and recovery
prospects;
d. Delegation of powers of various functionaries for taking decision on the purchase/ sale of the
financial assets; etc.
e. Accounting policy
ii. While laying down the policy, the Board shall satisfy itself that the bank has adequate skills to
purchase non performing financial assets and deal with them in an efficient manner which will
result in value addition to the bank. The Board should also ensure that appropriate systems and
procedures are in place to effectively address the risks that a purchasing bank would assume
while engaging in this activity.

iii) The estimated cash flows are normally expected to be realised within a period of three years
and not less than 5% of the estimated cash flows should be realized in each half year.

iv) A bank may purchase/sell non-performing financial assets from/to other banks only on 'without
recourse' basis, i.e., the entire credit risk associated with the non-performing financial assets
should be transferred to the purchasing bank. Selling bank shall ensure that the effect of the sale
of the financial assets should be such that the asset is taken off the books of the bank and after
the sale there should not be any known liability devolving on the selling bank.

v) Banks should ensure that subsequent to sale of the non performing financial assets to other
banks, they do not have any involvement with reference to assets sold and do not assume
operational, legal or any other type of risks relating to the financial assets sold. Consequently, the
specific financial asset should not enjoy the support of credit enhancements / liquidity facilities in
any form or manner.

vi) Each bank will make its own assessment of the value offered by the purchasing bank for the
financial asset and decide whether to accept or reject the offer.

vii) Under no circumstances can a sale to other banks be made at a contingent price whereby in
the event of shortfall in the realization by the purchasing banks, the selling banks would have to
bear a part of the shortfall.

viii) A non-performing asset in the books of a bank shall be eligible for sale to other banks only if it
has remained a non-performing asset for at least two years in the books of the selling bank.

ix) Banks shall sell non-performing financial assets to other banks only on cash basis. The entire
sale consideration should be received upfront and the asset can be taken out of the books of the
selling bank only on receipt of the entire sale consideration.

x) A non-performing financial asset should be held by the purchasing bank in its books at least for
a period of 15 months before it is sold to other banks. Banks should not sell such assets back to
the bank, which had sold the NPFA.

(xi) Banks are also permitted to sell/buy homogeneous pool within retail non-performing financial
assets, on a portfolio basis provided each of the non-performing financial assets of the pool has
remained as non-performing financial asset for at least 2 years in the books of the selling bank.
The pool of assets would be treated as a single asset in the books of the purchasing bank.

xii) The selling bank shall pursue the staff accountability aspects as per the existing instructions in
respect of the non-performing assets sold to other banks.