NON PERFROMING ASSSETS

1. Introduction

2. Indian banking system post and pre liberalization

3. Narashima committee report

4. Meaning of non-performing assets

5. Sarfasei act,2002

6. Buying and selling of npa

7. Comparative view

8. Conclusion.

9. Bibliography
 INTRODUCTION

The banking system in India is significantly different from that of other Asian nations

because of the country’s unique geographical, social, and economic characteristics. The

banking system has had to serve the goals of economic policies enunciated in

successive five year development plans, particularly concerning equitable income

distribution, balanced regional economic growth, and the reduction and elimination of

private sector monopolies in trade and industry.

“Sound finances are absolutely necessary for a stable and prosperous economy”. 1 The

banks in India have a great role to be played in the process. But a big challenge being

faced by the Indian banks is how, under the present ownership structure, to attain

operational efficiency suitable for the modern financial intermediation. On the other

hand, the mounting problem of Non Performing Assets (NPA) in the Private and public

sector banks poses a great threat on the future stability of the banking system.

The most basic function of the banks is to accept the deposits from the person who

have money in excess and lent out to those who needs it. However, not all loans

advanced by banks are realized which in turn leads to Bad Debts or in Legal Parlance

what are known as Non- Performing Assets (NPAs) or Non-Performing Loans (NPLs).

1
State and Government in Ancient India, A.S.Altekar, Page No.262, Para 1
INDIAN BANKING SYSTEM PRE LIBERLISATION AND POST LIBERLISATION

The pre-liberalization era was marked by the crisis which developed in the Indian

banking System towards the end of the Eighties. The period also witnessed the

economic crisis faced by the Government. The efforts made initially to revive the

banking sector in India were slow to be taken and accepted. Decades of non-

commercial orientation, directed lending, loan waivers and increasing non-performing

asset had made banks difficult to adjust to the reform culture. Therefore urgent

reformation of the system became the need of the time.

In the 1991’s under the ambit of the liberalization policy the banking sector witnessed

the reforms which changed the entire banking scenario in the country. To bring in

reforms in the banking sector the Narashima-I & II Committee was been formed by the

government. The purpose of Narashima committee-I was to study the functioning,

organizational structure and other procedural aspects of the financial systems in India.

The committee pointed out in their report that major reason for rising non- performing

assets of the banks was their increased lending to the “priority sector”. Subsequently,

the Narashima Committee-II also concluded the need for “zero” non-

performing assets for all Indian banks. The major contribution of the

committee was the recommendation for establishment of the Asset

Reconstruction Companies to take over the non performing assets of the

banks, allowing them to clear the bad-debts from their balance sheets. This

lead to the ambit of the Securitization and Reconstruction of Financial Assets

and Enforcement of Security Interest Act, 2002 (referred herein as

of the banks with the help of Asset Reconstruction Companies (ARC).

NON-PERFORMING ASSETS MEANING AND DEFINITION:

In simple terms non-performing asset means a financial asset of the bank which has

stopped earning the expected returns. The RBI defines Non-Performing Asset as “an

asset, including a leased asset, becomes non-performing when it ceases to generate

income for the bank”.2A Non-Performing Asset (NPA) is a loan or an advance where;

a) Interest and/ or installment of principal remain overdue for a period of more than 90

days in respect of a term loan,

b) The account remains ‘out of order’ in respect of an Overdraft/Cash Credit (OD/CC),

c) The bill remains overdue for a period of more than 90 days in the case of bills

purchased and discounted,

d) The installment of principal or interest thereon remains overdue for two crop

seasons for short duration crops,

e) The installment of principal or interest thereon remains overdue for one crop season

for long duration crops.

As per the RBI guidelines on Prudential Norms on Income Recognition, Asset

Classification and provisioning the banks are required to classify their non

performing assets into 3 categories based on the period for which the asset has

remained non- performing.3

2
RBI vide Circular No. 2006-07/31DBOD No. BP BC. 15 / 21.04.048 / 2006-07 dated July 1, 2006.
3
www.rbi.com- Prudential Norms on Income Recognition, Asset Classification and Provisioning -
Pertaining to Advances
 i) Sub-standard Assets: A sub-standard asset would be one, which has

remained NPA for a period less than or equal to 12 months. In such cases,

the current net worth of the borrower/ guarantor or the current market value of

the security charged is not enough to ensure recovery of the dues to the

banks in full.

ii) Doubtful Assets: An asset would be classified as doubtful if it has remained

in the sub-standard category for a period of 12 months. 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.

iii) Loss Asset: A loss asset is one where loss has been identified by the bank

or internal or external auditors or the RBI inspection but the amount has not

been written off wholly. 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 recovery value.

The SARFAESI Act provides the necessary impetus for the banks to recover value

from NPAs. Non-Performing Assets have been defined by the Act as an asset or

account of a borrower, which has been classified by a bank or financial institution as

Sub-standard, Doubtful or Loss asset--

(a) in case such bank or financial institution is administered or regulated by any

authority or body established, constituted or appointed by any law for the time being in
force, in accordance with the directions or guidelines relating to assets classifications

issued by such authority or body;

(b) in any other case, in accordance with the directions or guidelines relating to asset

classifications issued by the RBI.4

The concept of NPA’s can be illustrated better with help of the following example. A

bank ‘X’ gives a housing loan to ‘Mr.Y’ to be repaid over a period of 3 yrs on the

mortgage of the title deeds of Mr.Y’s shop. Mr.Y has to pay monthly installments in the

form of EMIs to the bank. Now Mr.Y makes a default in making one monthly installment,

as the banks follow the policy of good-faith, they will make telex-calls to the customer

informing him about his default. In case the default of the borrower continues for a

period of 90 days, the bank will classify his account as NPA on the 91 st day. Then the

further efforts are made by the bank for enforcing their security interest.

Non-Performing Assets and Asset Reconstruction Companies:

The Narsimham Committee which was the first to propose an Asset Reconstruction

Company (ARC) as a means of tackling the burgeoning problem of bad and doubtful

accounts of financial institutions in India. To provide the necessary legal footing for

ARCs, the Government passed the Securitization and Reconstruction of Financial

Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 on the

recommendations of the Narsimhan Committee I and II and the Andhyarujina

Committee.

4
Section 2 (1) (o), SARFAESI Act, 2002.
The Act provides a regulatory framework for setting up of Asset Reconstruction

Companies (ARCs) in India and seeks to regulate securitization and reconstruction of

financial assets and enforcement ofsecurity interests.

It further enumerates the procedure for the establishment of Asset Reconstruction

Companies in order to resolve the mushrooming problem of NPAs which is as follows:

 Obtaining a Certificate of Registration from the Reserve Bank of India. 5

 Having Net Owned Fund of not less than Rs. 100 crore or such amount as would

enable the ARC tomaintain Capital Adequacy Ratio of at least 15% of the

financial assets acquired/ proposed to be acquired by the ARC. 6

 The directors of Securitization Company or Reconstruction Company should

have adequate professional experience in matters relating to finance,

securitization and reconstruction;

 That a sponsor, is not holding a Securitization Company or Reconstruction

Company, as the case may be, or, does not otherwise hold any controlling

interest in such Company;

That the Securitization Company or Reconstruction Company has complied with or is in

a position to comply with the prudential norms specified by RBI

5
Section 3, SARFAESI Act, 2002.
6
RBI/2004/126 Notification No. DNBS.4/ED (SG)/-2004 dated March 29, 2004
.