What is NPA?

: Banking businesses is mainly that of borrowing from the public and lending
it to the needy persons and business at a premium. Lending of money involves a credit risk.
When the loans and advances made by banks or financial institutions turnout as non -
productive, non-rewarding and non - remunerative then they will become Non – Performing
Assets (NPA). NPA is an asset or account of a borrower, which is classified by a bank or
financial institution as sub-standard asset, doubtful asset
and loss asset .
The NPA were to be reckoned on past due basis prior to 31.3.2001. As per the guidelines if
the amount remained past due for more than two quarters it is treated as NPA. When the
advance remains outstanding for 30 days beyond the due date it is past due as per RBI
classification issued in December 1992. (!) Out of order means outstanding balance in the
overdraft / cash credit account which remains continuously in excess of the sanctioned limit
for 6 months. If the outstanding balance in principal Over draft and Cash credit is less than
the sanctioned limit but there is no credit balance for 6 months or balance is not enough to
cover interest debited for the period, then such account is also to be taken as out of order.
Over the years the criteria for NPA regulations have become stricter. RBI reports said that
these stricter guidelines are issued for improvements in the payment and settlement
systems, recovery climate and up gradation of technology in the banking system.

Factors Contributing NPAs: The factors contributing to NPAs are:

1. Diversification of funds for expansion, modernization undertaking of new projects and
also for helping associate concerns. This is coupled with recessionary trends and failure to tap
required funds in the capital and debt market.
2. Business (Product, marketing, financial) failure, inefficient management, strained labor
relations, inappropriate technology, outmoded machinery, technical problems and product
obsolescence.
3. Recession, input and power shortage, price escalation, accidents, natural calamities,
external problems in other countries leading to non –
payment of over dues.
4. Time and cost over run during project implementation stage.
5. Government policies like changes in excise duties, pollution control, poor credit decisions,
priority sector lending and outdated legal systems.
6. Willful default, siphoning off funds, fraud and misappropriation by promoters and
directors dispute.
7. Deficiencies on the part of banks like delay in release of funds and delay in release of
subsidies by government.
8. Delay in finalization of rehabilitation package by the board of Industrial and
Reconstruction (BIFR).
9. Absence of written policies.
10. The absence of portfolio concentration limits, poor industry analysis, cursory financial
analysis of borrowers.
11. Inadequate customers contract
12. Excessive reliance on collateral, absence of follow up action by banks, poor control on
loan documentation.
13. Absence of asset classification and loan loss provisioning standards and
14. The lack of co-ordination between the financial institutions and commercial banks,
which provide long-term needs of industry that, enables the industry to misuse the funds.
Impact of NPAs on Banking Operations:

The efficiency of a bank is not reflected only by the size of its balance sheet but also the level
of return on its assets. The NPAs do not generate interest income for banks but at the same
time banks are required to provide provisions for NPAs from their current profits. The NPAs
have deleterious impact on the return on assets in the following ways.

The interest income of banks will fall and it is to be accounted only on receipt basis.
1. Banks profitability is affected adversely because of the providing of doubtful debts and
consequent to writing it off as bad debts.
2. Return on investments (ROI) is reduced.
3. The capital adequacy ratio is disturbed as NPAs are entering into its calculation.
4. The cost of capital will go up.
5. The assets and liability mismatch will widen.
6. The economic value addition (EVA) by banks gets upset because EVA is equal to the net
operating profit minus cost of capital and
7. It limits recycling of the funds.

It is due to above factors the public sector banks are faced with bulging NPAs which results
in lower income and higher provisioning for doubtful debts and it will make a dent in their
profit margin. In this context of crippling effect on banks operation the slew asset quality is
placed as one of the most important parameters in the measurement of banks performance
under the Camel’s supervisory rating system of RBI.

Measures to Control NPAs Menace: It is proved beyond doubt that NPAs in bank ought to
be kept at the lowest level. Two pronged approaches viz.
1. Preventive management and
2. Curative management would be necessary for controlling NPAs.

Preventive Management:

Credit Assessment and Risk Management Mechanism: A lasting solution to the problem
of NPAs can be achieved only with proper credit assessment and risk management
mechanism. The documentation of credit policy and credit audit immediately after the
sanction is necessary to upgrade the quality of credit appraisal in banks. In a situation of
liquidity overhang the enthusiasm of the banking system is to increase lending with
compromise on asset quality, raising concern about adverse selection and potential danger of
addition to the NPAs stock. It is necessary that the banking system is equipped with
prudential norms to minimize if not completely avoid the problem of credit risk.

Organisational Restructuring: With regard to internal factors leading to NPAs the onus for
containing the same rest with the bank themselves. These will necessities organizational
restructuring improvement in the managerial efficiency, skill up gradation for proper
assessment of credit worthiness and a change in the attitude of the banks towards legal action,
which is traditionally viewed as a measure of the last resort.

Reduce Dependence on Interest: The Indian banks are largely depending upon lending and
investments. The banks in the developed countries do not depend upon this income whereas
86 percent of income of Indian banks is accounted from interest and the rest of the income is
fee based. The banker can earn sufficient net margin by investing in safer securities though
not at high rate of interest. It facilitates for limiting of high level of NPAs gradually. It is
possible that average yield on loans and advances net default provisions and services costs do
not exceed the average yield on safety securities because of the absence of risk and service
cost.

Potential and Borderline Npas under Check: The potential and borderline accounts require
quick diagnosis and remedial measures so that they do not step into NPAs categories. The
auditors of the banking companies must monitor all outstanding accounts in respect of
accounts enjoying credit limits beyond cut – off points, so that new sub-standard assets can
be kept under check.

Curative Management: The curative measures are designed to maximize recoveries so that
banks funds locked up in NPAs are released for recycling. The Central government and RBI
have taken steps for arresting incidence of fresh NPAs and creating legal and regulatory
environment to facilitate the recovery of existing NPAs of banks. They are:

Debt Recovery Tribunals (DRT): In order to expedite speedy disposal of high value claims
of banks Debt Recovery Tribunals were setup. The Central Government has amended the
recovery of debts due to banks and financial institutions Act in January 2000 for enhancing
the effectiveness of DRTs. The provisions for placement of more than one recovery officer,
power to attach dependents property before judgment, penal provision for disobedience of
Tribunals order and appointment of receiver with powers 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 times to come.

Lok Adalats: The Lok adalats institutions help banks to settle disputes involving accounts in
doubtful and loss categories. These are proved to be an effective institution for settlement of
dues in respect of smaller loans. The Lok adalats and Debt Recovery Tribunals have been
empowered to organize Lok adalats to decide for NPAs of Rs. 10 lakhs and above.

Asset Reconstruction Company (ARC): The Narasimham Committee on financial system

(1991) has recommended for setting up of Asset Reconstruction Funds (ARF). The following
concerns were expressed by the committee.
1. It was felt that centralized all India fund will severely handicap in its recovery efforts by
lack of widespread geographical reach which individual bank posses and.
2. Given the large fiscal deficits, there will be a problem of financing the ARF.
Subsequently, the Narasimham committee on banking sector reforms[5] has
recommended for transfer of sticky assets of banks to the ARC. Thereafter the Varma
committee on restructuring weak public sector banks has also viewed the separation of NPAs
and its transfer thereafter to the ARF is an important element in a comprehensive
restructuring strategy for weak banks. In recognition of the same ARC Bill was passed to
regulate Securitization and Reconstruction of financial assets and enforcement of security
interest. The ICICI BANK, State Bank of India and IDBI have promoted the country’s first
Asset Reconstruction Company. The company is specialized in recovery and liquidation of
assets. The NPAs can be assigned to ARC by banks at a discounted price. The objective of
ARC is floating of bonds and making necessary steps for recovery of NPAs from the
borrowers directly. This enables a one time clearing of balance sheet of banks by sticky
loans.
Corporate Debt Restructuring (CDR): The corporate debt restructuring is one of the
methods suggested for the reduction of NPAs. Its objective is to ensure a timely and
transparent mechanism for restructure of corporate debts of viable corporate entities affected
by the contributing factors outside the purview of BIFR, DRT and other legal proceedings for
the benefit of concerned. The CDR has three tier structure viz., a. CDR standing forum
b. CDR empowered group and c. CDR cell.

The Mechanism of the CDR: It is a voluntary system based on debtors and creditors
agreement. It will not apply to accounts involving one financial institution or one bank
instead it covers multiple banking accounts, syndication, consortium accounts with
outstanding exposure of Rs. 20 crores and above by banks and institutions. The CDR system
is applicable to standard and sub – standard accounts with potential cases of NPAs getting a
priority. In addition to the steps taken by the RBI and Government of India for arresting the
incidence of new NPAs and creating legal and regulatory environment to facilitate for the
recovery of existing NPAs of banks, the following measures were initiated for reduction of
NPAs.

Circulation of Information of Defaulters: The RBI has put in place a system for periodical
circulation of details of willful defaulters of banks and financial institutions. The RBI also
publishes a list of borrowers (with outstanding aggregate rupees one crore and above) against
whom banks and financial institutions in recovery of funds have filed suits as on 31st March
every year. It will serve as a caution list while considering a request for new or additional
credit limits from defaulting borrowing units and also from the directors, proprietors and
partners of these entities.

Recovery Action Against Large NPAs: The RBI has directed the PSBs to examine all cases
of wilful default of Rs. One crore and above and file criminal cases against willful defaulters.
The board of directors are requested to review NPAs accounts of one crore and above with
special reference to fix staff accountability in individually. It is observed from the above table
that the gross NPAs of the banks is gradually declining from Rs. 68717 crores in 2002 - 03 to
Rs. 50552 crores in 2006 – 07 whereas the net recovery of NPAs is increasing from Rs.
23183 crores in 2002 - 03 to Rs. 27176 crores in 2006 – 07. It shows that the banks
have taken strenuous efforts to contain the NPAs. Moreover the percentage of recovery to
gross NPAs is also in the increasing trend.

Credit Information Bureau: The institutionalization of information sharing arrangement is

now possible through the newly formed Credit Information Bureau of India Limited (CIBIL)
It was set up in January 2001, by SBI, HDFC, and two foreign technology partners.
This will prevent those who take advantage of lack of system of information sharing amongst
leading institutions to borrow large amount against same assets and property, which has in no
measures contributed to the incremental of NPAs of banks.

Conclusion: It is needless to mention, that a lasting solution to the problem of NPAs can be
achieved only with proper credit assessment and risk management mechanism. In a situation
of liquidity overhang, the enthusiasm of the banking system to increase lending may
compromise on asset quality, raising concern about their adverse selection and potential
danger of addition to the stock of NPAs. It is necessary that the banking system is to be
equipped with prudential norms to minimize if not completely to avoid the problem of NPAs.
The onus for containing the factors leading to NPAs rests with banks themselves. This will
necessitates organizational restructuring, improvement in the managerial efficiency and skill
upgradation for proper assessment of credit worthiness It is better to avoid NPAs at the
nascent stage of credit consideration by putting in place of rigorous and appropriate credit
appraisal mechanisms. Having regard to strong possibilities of NPAs assuming high
proportion of total assets, unless the authorities for preventing mounting NPAs thereby
eroding the profitability and liquidity of the banks initiate serious corrective action. At the
outset NPAs are considered to be gloomy as well as greedy to the Indian economy.