INTRODUCTION 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. The debtor take the funds from the bank in the form of credit and he have to payback the principle amount with the interest to the creditor as a result the creditor (Bank)gets the profit in the form of interest and again this profit is reinvested leading to the growth of the economy.
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. Due to non performance of the fund the financial institutions become 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 Financial companies and institutions are nowadays facing a major problem of managing the Non Performing Assets (NPA) as these assets are proving to become a major setback for the growth of the economy.
Undoubtedly, the world economy has slowed down. Globally stock markets have tumbled and business itself is getting hard to do with the simple reason that the banks (creditor) money in the form of funds get blocked. Under such a situation, it goes without saying that banks are no exception and are bound to face the heat of a global downturn. NON PERFORMING ASSET Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by RBI.
An amount due under any credit facility is treated as “past due” when it has not been paid within 30 days from the due date. Due to the improvement in the payment and settlement systems, recovery climate, up gradation of technology in the banking system, etc. , it was decided to dispense with ‘past due’ concept, with effect from March 31, 2001. Accordingly, as from that date, a Non performing asset (NPA) shell be an advance where; i. interest and /or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan, ii. he account remains ‘out of order’ for a period of more than 180 days, in respect of an overdraft/ cash Credit(OD/CC), iii. the bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted, iv. interest and/ or installment 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 purpose, and v. any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.
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, form the year ending March 31, 2004. Accordingly, with effect form March 31, 2004, a non-performing asset (NPA) shell be a loan or an advance where; i. interest and /or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan, ii. the account remains ‘out of order’ for a period of more than 90 days, in respect of an overdraft/ cash Credit(OD/CC), iii. he bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, iv. interest and/ or installment 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 purpose, and v. any amount to be received remains overdue for a period of more than 90 days in respect of other accounts. Out of order An account should be treated as ‘out of order’ if the outstanding balance remains continuously in excess of the sanctioned limit/ drawing power.
In case 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 account 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. INCOME RECOGNITION 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 recognized 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. 2. Reversal of Income: a) 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 correspondence previous year, should be reversed or provided for if the same is not realised. ) In respect of NPAs, Fees, Commission and similar income that have accrued should have ceased to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected. c) Leased Assets: ? The net lease rentals on the leased asset accrued and credited in income account before he asset became non-performing should be reversed or provided for in the current accounting period. ? The term ‘ net lease rentals’ would mean the amount of finance charge taken in the credit of Profit & Loss Account and would be worked out as gross lease rentals adjusted by amount of Statutory Depreciation. 3.
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 bank’s global portfolio, including the advances at the foreign branches. ? While reporting NPA figures to RBI, the amount held in interest suspense account, should be shown as a deduction from gross NPA as well as gross advances while arriving at the net NPAs. ASSET CLASSIFICATION Banks are required to classify Non-performing assets further into the following three categories based on the period for which the asset has remained Non-performing and the realization of dues: a) Sub-standard Assets ) Doubtful Assets c) Loss Assets Figure 1. 1: Classification of Assets [pic] a) Sub-standard Assets: A sub standard asset was one, which was classified as NPA for a period not exceeding two years. With effect from 31st March 2001, a sub-standard asset is one, which has remained NPA for a period less than or equal to 18 months. Such assets will have well defined credit weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. b) Doubtful Assets: A doubtful asset was one, which remained NPA for a period exceeding two years.
With effect from 31st March 2001, an asset is to be classified as doubtful, if it has remained NPA for a period exceeding 18 months. With effect from March 31, 2005, an asset would be classified as doubtful if it remained in the sub-standard category for 12 months. c) Loss Assets: A loss asset is one where the Bank or external Auditors or the RBI inspection has identified loss but the amount has not been written off wholly. 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.
GUIDELINES FOR CLASSIFICATION OF ASSETS 1. Classification of Assets: The assets should be classified into above categories taking into account the degree of well defined credit weaknesses and the extent of dependencies on collateral security for realization of dues. 2. Banks should establish appropriate internal systems: The internal systems should be established by banks to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value of accounts. 3. Account 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 as such as non-availability of adequate drawing power based on latest stock. 4. Asset 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 a part thereof, which has become irregular. 5. Advances under consortium arrangements:
Asset classified 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. 6. Accounts where there is erosion in the value of security: Erosion in the value of security can be reckoned as significant when the realizable value of the security is less than 50 percent 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. . Agricultural advances: a) 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. b) Where the 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 or re-schedulement of the repayment period. ) 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. 8. Restructuring/ Rescheduling of Loans: A standard asset where the terms of the loan agreement regarding interest and principal have been renegotiated or rescheduled after the 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 restructured terms.
In case of substandard and doubtful assets also, rescheduling does not entitle a bank to upgrade the quality of advances automatically unless there is satisfactory performance under the rescheduled/ renegotiated terms. 9. Exceptions: 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 will not be applied to restructuring/ rescheduling of credit facilities extended to traders.
IMPORTANT COMMITTEES The Tandon Committee (1973) was the first committee in Indian Banking sector to set a proper quality wise grading system of advance portfolio. This was followed by the Chore Committee (1980) which was recognised the need for close watch on the quality of loan portfolio. Phendarkar Committee (1981) recognised the need for classifying advance into different categories to index the overall quality of asset portfolio. This was the starting point for the introduction of the health coding system of categorizing bank loan portfolio by the RBI in 1985. his 8 band concept of health coding of advance accounts from health code 1 to 8 was followed by a circular from RBI to Banks (1989), specifying the need to redefine the practise of charging the interest on loans and advances by the banks on new prudential criteria in line with international practises by ceasing to charge interest on Non performing advances. Narsihmam Committee submitted its first report on November 1991 and gave more specific criteria for prudential norms of income recognition, asset classification, Provisioning and capital adequacy norms.
Narsihmam Committee gave its second report in 1998. He strongly opposed the merger of strong banks with weak ones as this would cause in a negative impact on the asset quality of the stronger bank because of the “contaminated portfolio” of the weak banks. The committee has not made any suggestions to deal with the extremely high non-performing assets of Indian banks, but has suggested that the concept of an Asset Reconstruction Fund be considered. ASSET RECONSTRUCTION COMPANY
The Government has proposed an initial paid-up capital of Rs 1,400 crore and an authorised capital of Rs 2,000 crore for the ARC. In view of the large equity base, the Government is keen to ensure the participation of the maximum number of institutional shareholders to cobble up the amount. The task of the ARC would be to buy out the bad assets of banks and FIs and make efforts for their recovery while compensating the lenders at a negotiated price for the assets taken over.
The Government has been catalysing the setting up of the ARC within the existing legal framework. The Ministry of Finance is simultaneously processing a legislative Bill to provide the required legal backing to the entity in future to ensure its smooth functioning. While seeking multilateral support for the new company, the Government had initially approached all the three agencies — the World Bank, ADB and IFC — to explore their willingness to take an equity stake in what would be the country’s first ARC. PROVISIONING FOR NPAs
Taking into account the time lag between account becoming doubtful of recovery, its recognition as such, the realization of the security and the erosion in the value of security over time charged to the banks, it has been advised by RBI that banks should make provisions against sub-standard assets, doubtful assets and loss assets, as under: ? Loss Assets – The entire assets should be written off, if the assets are permitted to remain in the books for many reason, 100% of the outstanding should be provided for. Doubtful Assets – 100%of the extent to which the advance is not covered by the realizable value of the security to which the bank has a valid recourse and the realizable value is estimated on a realistic basis. ‘sub – Standard Assets – A general provision of 10%of total of the outstanding. In terms of RBI guidelines, as and when an asset becomes a NPA, such advances would be first classified as a sub-standard one for a period that should not exceed 18 months and subsequently as doubtful assets.
It should be noted that the above classification is only for the purpose of computing the amount of provision that should be made with respect to bank advances and certainly not for the purpose of presentation of advances in the banks balance sheet. The third schedule to the Banking Regulation Act, 1949, solely governs presentation of advances in the balance sheet. Banks have started issuing notices under the Securitization Act, 2002 directing the defaulter to either pay back the dues to the bank or else give the possession of the secured assets mentioned in the notice.
However, there is a potential threat to recovery if there is substantial erosion in the value of security by the borrower or if the borrower has committed fraud. Under such a situation it will be prudent to directly classify the advance as a doubtful or loss asset, as appropriate. Reserve Bank of India (RBI) has merely laid down the minimum provisioning requirement that should be complied with by the concerned bank on a mandatory basis. However, where there is a substantial uncertainty to recovery, higher provisioning should be made by the bank concerned. Table 1. 1: Provisioning for NPAs |Sr. No. Categories |Days Past Due |Provisioning Requirements | |1 |Sub standard | |10% | |2 |Doubtful |i) upto 1 yr |100% of unsecured + 20% of secured portion | | | |ii) 1 to 3 yr |100% of unsecured + 30% of secured portion | | | |iii) more than 3 yrs |100% of unsecured + 50% of secured portion | |3 |Loss | |100% | Note: Implementation of the instructions requiring classification of substandard account into doubtful category after 12 months and 100 % provisioning for secured portion of doubtful assets of over 3 years would be deferred by three years.
As such the banks should build up adequate provisions over this period to facilitate smooth transition. ADVANCES AND GENERAL INSTRUCTION In whatever form bank advances are granted, they are repayable on demand or at the expiry of some fixed period. Bill of exchange discounted are payable on maturity. Overdrafts and Cash Credits are legally repayable on demand, although the bank seldom exercises the right except in circumstances mentioned below. Loans are payable on the expiry of the periods for which they are granted. In case the loan is repayable in installments and default occurs in the payment of any installment, the entire loan usually becomes immediately recoverable at the option of the bank. Recalling of Advances
Banks conduct a regular scrutiny of all the advances and ensure that timely action is taken in each case either for the continuance of the facility on the existing terms or with such modifications as may be considered necessary or for the recovery of the amount if it is decided not to continue the facility. Advances are usually called under the following circumstances: ? death of the borrower or the guarantor. ? Insolvency of the borrower or the guarantor. ? Dissolution of the partnership. ? Failure to renew the document sufficiently before the expiry of the period of limitation. ? Failure to adhere to the terms and conditions of the sanction in spite of bank’s repeated requests. Deterioration of the security. ? Deterioration of the financial position of the party. ? Change in the bank’s policy regarding certain types of advances. The bank may at any time decide to restrict against certain commodities because of their overproduction. ? There may also be other reasons for withdrawing the facility e. g. the law and order situation in a certain place is such that it may be risky to continue the advance there. In the cases stated above, the bank endeavors to recover the advance by making the formal demand and thereafter, if necessary, by putting pressure on the borrower or his legal representatives, as the case may be, with a threat of legal action.
If there is a guarantor he is also called upon to adjust the account or have it adjusted by the principal. Much will however depend on the honesty of the purpose of the borrower and his legal position at that time. If he is already heading towards insolvency, any indulgence shown to him may further complicate matters for the bank. If the threat of litigation does not have the desired effect, the bank may consider filing a suit. It must however be remembered that the legal proceedings entail a good deal of delay and expenses and the results in the long run are generally not satisfactory. CAUSES FOR RISE IN NPA The RBI has summarized the finer factors contributing to higher level of NPAs in the Indian banking sector as: ?
Diversion of funds, which is for expansion, diversification, modernization, undertaking new projects and for helping associate concerns. This is also coupled with recessionary trends and failures to tap funds in capital and debt markets. ? Business failures (such as product, marketing etc. ), which are due to inefficient management system, strained labor relations, inappropriate technology/ technical problems, product obsolescence etc. ? Recession, which is due to input/ power shortage, price variation, accidents, natural calamities etc. The externalization problems in other countries also lead to growth of NPAs in Indian banking sector. ? Time/ cost over run during project implementation stage. Governmental policies such as changes in excise duties, pollution control orders etc. ? Willful defaults There are borrowers who are able to payback 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. ? Deficiency on the part of banks, viz, delays in release of limits and payments/ subsidies by the Government of India. ? Ineffective recovery tribunal The Govt. has set of number 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, their by reducing their profitability and liquidity. 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. anking 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. HIGH COST DUE TO NPA Quite often genuine borrowers face the difficulties in raising funds from banks due to mounting NPAs. Either the bank is reluctant in providing the requisite funds to the genuine borrowers or if the funds are provided, they come at a very high cost to compensate the lender’s losses caused due to high level of NPAs. Therefore, quite often corporate prefer to raise funds through commercial papers (CPs) where the interest rate on working capital charged by banks is higher.
With the enactment of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, banks can issue notices to the defaulters to pay up the dues and the borrowers will have to clear their dues within 60 days. Once the borrower receives a notice from the concerned bank and the financial institution, the secured assets mentioned in the notice cannot be sold or transferred without the consent of the lenders. The main purpose of this notice is to inform the borrower that either the sum due to the bank or financial institution is paid by the borrower or else former will take action by way of taking over the possession of assets . Besides assets, banks can also takeover the management of the company.
Thus the bankers under the aforesaid Act will have the much needed authority to either sell the assets of the defaulting companies or change their management. RESERVE BANK GUIDELINES ON PURCHASE/ SALE OF NON PERFORMING FINANCIAL ASSETS Scope: ? These guidelines would be applicable to banks, FIs and NBFCs purchasing/ selling non performing financial assets, from/ to other banks/FIs/NBFCs (excluding securitization companies/ reconstruction companies). ? 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. ? The reference to ‘bank’ in the guidelines would include financial institutions and NBFCs. Structure: 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: ? Procedure for purchase/ sale of non performing financial assets by banks, including valuation and pricing aspects. ? Prudential norms, in the following areas, for banks for purchase/ sale of non performing financial assets: o Asset classification norms o Provisioning norms o Accounting of recoveries o Capital adequacy norms o Exposure norms ? Procedure for purchase/ sale of non performing financial assets, including valuation and pricing aspects: ?
A bank which is purchasing/ selling non-performing financial assets should ensure that the purchase/ sale is conducted in accordance with a policy. The Board shall lay down following policies and guidelines: o Non performing financial assets that may be purchased/ sold; o Norms and procedure for purchase/ sale of such financial assets; o Valuation procedure to be followed to ensure that the economic o Value of financial assets is reasonably estimated based on the estimated cash flows arising out of repayments and recovery prospects o Delegation of powers of various functionaries for taking decision on the purchase/ sale of the financial assets; etc. ? Accounting policy: 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. o 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. o 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. REMEDIES TO CONTROL NPAs Non Performing Assets negatively affects the profitability of banks. More the proportion of NPAs in the organizations less would be the profit. In order to control NPAs some remedies are available which are discussed as follows: Following are the remedies that are available in order to control NPAs: 1. Strict follow-up: In order to control NPAs strict follow up is necessary.
The borrower must be reminded of paying the installment money before the due date. And in case of non payment of installment, the reasons for the same should be asked. 2. Effective credit appraisal: There should also be effective credit appraisal for controlling NPAs. For this monthly income should be strictly verified. Also the credit worthiness and financial status should be verified. 3. Funding limit: In order to control NPAs there should be maximum limit on the amount of finance which has to be given to the borrowers. 4. Educating staff: There is a need to educate the staff regarding the various aspects of NPAs. They should have the knowledge about RBI’s guidelines related to NPAs. 5. Monitoring the use of funds:
This is another remedy which is available for managing and controlling NPAs. 6. Proper field investigation: Field investigation should be proper and strict. Specialized persons should be appointed for this task. GENERAL METHODS OF MANAGEMENT OF NPAs The management of NPA is the difficult task in practice. Management of NPAs means, how to settle the NPAs account in the books. In simple it focuses on the methods of settlement of NPAs account. The methods are differs from bank to bank. The following paragraph explains some general methods of Management of NPAs by the banks. The same information is given in the following chart: Figure 1. 2: General Methods of Management of NPAs Compromise:
The dictionary meaning of the term compromise is settlement of dispute reached by mutual concessions. The following are the detailed guidelines for compromise/negotiated settlements of NPAs. ? The compromise should be a negotiated settlement under which the bank should ensure recovery of its dues to the maximum extent possible of minimum expenses. ? Proper distinction should be made between willful defaulters and borrowers defaulting in repayments due to circumstances beyond their control. ? Where security is available for assessing the realizable value, proper weight age should be given to the location, condition and marketable title and possession of sub security.
An advantage in settlement cases is that banks can promptly recycle the funds instead of resorting to expensive recovery proceedings spread over a long period. ? All compromise proposals approved by any functionary should be promptly reported to the next higher authority for post facto scrutiny. ? Proposal for write off/ compromise should be first by a committee of senior executives of the bank. ‘special recovery cells should be set up at all regional levels. Legal remedies: The legal remedies are one of the methods of management of NPAs. The banks observed that the borrower is making willful default; no more time should be lost instituting appropriate recovery proceedings. The legal remedies are filling of civil suits. Regular Training Program:
The all levels of executives are compelling to undergrowth the regular training program on credit and NPA management. It is very useful and helpful to the executives for dealing the NPAs properly. Recovery Camps: The banks should conduct the regular or periodical recovery camps in the bank premises or some other common places; such type of recovery camps reduces the level of NPAs in the Banks. Write offs: Write offs is also one of the common management techniques of NPAs. The assets are treated as loss assets, when the bank writes off the balances. The ultimate aim of the write off is to cleaning the Balance sheet. Spot Visit: The bank officials should visit to the borrowers’ business place or borrowers field regularly or periodically.
It is also help full to the bank to control or reduce the NPAs limit. Rehabilitation of potentially viable units: The unit is sick due to technical obsolescence’s of inefficient management or financial irregularities. When the Bank settles the dues, of such, companies through the compromise or through the legal actions the better is to be followed. Other Methods: • Persistent phone calls. • Media announcement. UPGRADATION OF NPA ACCOUNTS As per Reserve Bank of India guidelines, if the arrears of interest and the principal are paid by the borrower in case of loan accounts classified as NPAs, the account should no longer be treated as non performing and should be classified as Standard account.
In view of these guidelines, NPA accounts should be upgraded to Standard Category and accordingly classification of account in the system be changed on adjustment of up to date irregularity, under intimation to Corporate Office as well as Circle Office. However, the above guidelines shall not apply to restructured/ rescheduled NPA accounts where, as per RBI guidelines, an account can be upgraded only after the account has run satisfactorily for one year after its reschedulement and recovery due as per reschedulement plan has been effected Although large number of studies relating to NPAs had been conducted by the researchers and various financial institutions.
However, not much work had been done with reference to the causes of occurrence of NPAs and remedies to control NPAs. In brief the study conducted in the area of NPAs was given here: Meeker and Gray (1983) studied the non-performing loans as an indicator of asset quality. The public was given its first opportunity to review bank asset quality in the form of non-performing asset information. The purpose of this study was to evaluate that information. A regression analysis was used in comparing the non-performing asset statistics with examiner classifications of assets. It suggested that the non-performing asset information can be useful aid in analyzing the asset quality of banks, particularly when the information is timely. Barth et al. 2002) conducted a cross-country analysis on Bank Safety and Soundness and the Structure of Bank Supervision. Two central questions about the structure of bank supervision were whether central banks should supervise banks and whether to have multiple supervisors. They used data for 70 countries across developed, emerging and transition economies to estimate statistical connections between banking performance, the structure of bank supervision, permissible banking activities, legal environments, banking market structure and macroeconomic conditions. They found that where central banks supervise banks, banks tend to have more non-performing loans. Countries with multiple supervisors have lower capital ratios and higher liquidity risk.
We also find that conclusions from non-transition economies may not necessarily apply to transition economies. Feltenstein and Sarangi (2002) developed a model for the analysis of macroeconomic management that was caused by failures in the private banking system. The analysis was applied to Tanzania, a country that faces significant difficulties from a banking system that holds large quantities of non-performing assets. A dynamic general equilibrium model was constructed that was solved numerically. As initial examples, first the model was simulated, using historical exogenous parameters, and endogenous macro outputs with corresponding historical outcomes were compared.
Then a program was imposed that attempted to increase the productivity, and hence solvency, of the private sector by increasing government expenditures on infrastructure, which were, in turn, financed by foreign capital flows. Finally, an improvement in the efficiency of public utilities was imposed. This change appeared to offer an avenue for improving the solvency of the banking system, the goal of this study. Toby (2007) examined selected financial indicators and their prudential implications for banking system soundness in Nigeria. For each of the hypothesized functional relationships, the Spearman’s rank correlation coefficient (r’) and the corresponding Freund-Williams significance test at the 5% level were calculated.
Under regimes of rising proportion of non-performing loans in the distressed banks, increasing bank liquidity and falling profitability, the paper found the selected capital adequacy ratios to be significantly correlated with bank solvency. It found that the cash reserve ratio correlates negatively and significantly with the proportion of non-performing loans (npls). It was also found that the cash and bank balances ratio correlates positively and significantly with the return on total assets. While the ratio of loans-to-deposits correlates negatively and significantly with bank solvency, the pre-tax profit margin correlates positively with bank solvency. Incremental capital requirements should be graduated in line with selected bank solvency and profitability projections.
An optimal loan-to-deposit ratio must have the objectives of increasing asset quality, long-run corporate growth, and facilitation of the monetary transmission mechanism. Vallabh, et al. (2007) made an empirical approach to the analysis of Non-Performing Assets (NPAs) of public, private, and foreign sector banks in India. The NPAs were considered as an important parameter to judge the performance and financial health of banks. The level of NPAs was one of the drivers of financial stability and growth of the banking sector. This paper aimed to find the fundamental factors which impact NPAs of banks. A model consisting of two types of factors, viz. macroeconomic factors and bank-specific parameters, was developed and the behavior of NPAs of the three categories of banks was observed. This model tried to extend the methodology of widely-known Altman model. The empirical analysis assessed how macroeconomic factors and bank-specific parameters affected NPAs of a particular category of banks. The results showed that movement in NPAs over the years can be explained well by the factors considered in the model for the public and private sector banks. The factors included in the model explained 97. 1% (adjusted R-square value of regression results) of variations in NPAs of public banks and 76. 9% of the same of private banks.
The other important results derived from the analysis include the finding that banks’ exposure to priority sector lending reduces NPAs. Kaino and Meso (2008) examined profit efficiency of commercial banks in Kenya after the financial sector reforms were undertaken in the early 1990s. By utilizing the stochastic frontier approach it estimated the annual profit efficiency scores for 17 commercial banks for the period, 1995-2004. The statistical tools used were ratios. Averages. The results showed an average of 65. 6% profit efficiency over the study period. However, the mean profit efficiency declined from 67. 9% in 1995 to 62. 9% in 2000, thereafter it increaseed consistently to 68% in 2003.
The initial decline in profit efficiency was due to the oligopolistic nature of the Kenyan banking sector and unfavorable macroeconomic environment that prevailed after the financial sector reforms. The improvement in efficiency towards the end of the study period was explained by increased competition in the banking sector, adoption of new technology and introduction of innovative products targeting different customer segments. The study further found that bad debts were concentrated in banks that reported low levels of profit efficiency. The study concluded that financial liberalization improved profit efficiency of the banks in the long run, and non-performing loans negatively affected banks’ profit efficiency.
To further improve the profit efficiency of the banks, the study recommended formulation of policies that reduce the non-performing loan burden, and encourage competition and sharing of infrastructure and technology. Singla (2008) undertook the present study to examine and understand how financial management played a crucial role in the growth of banking. It was concerned with examining the profitability position of the selected sixteen banks (BANKEX-based) for a period of five years (2000-01 to 2006-2007). The data had been analyzed with the help of statistical tools like ratios. The study revealed that the profitability position was reasonable during the period of study when compared with the previous years. Return on Investment proved that the overall profitability and the position of selected banks was sustained at a moderate rate.
With respect to debt equity position, it was evident that the companies were maintaining 1:1 ratio, though at one point of time it was very high. Interest coverage ratio was continuously increasing, which indicated the company’s ability to meet the interest obligations. Capital adequacy ratio was constant over a period of time. During the study period, it was observed that the return on net worth had a negative correlation with the debt equity ratio. Interest income to working funds also had a negative association with interest coverage ratio and the Non-Performing Assets (NPA) to net advances was negatively correlated with interest coverage ratio. Sinha (2008) had done the performance evaluation of Indian Commercial Banks in the Prompt Corrective Action Framework.
After the onset of banking sector reform in India, the Reserve Bank of India initiated a system of Prompt Corrective Action (PCA) with various trigger points and mandatory and discretionary responses by the supervising authority on a real time basis. The PCA framework relied on three major indicators of banking sector performance: Net Non Performing Asset (NPA), Capital-To-Risk-Weighted Assets Ratio (CRAR) and Return on Assets (ROA). The present paper seeked to combine the ratio approach adopted by the Reserve Bank of India with the Assurance Region based measure of technical efficiency to find out a composite Data Envelopment Analysis (DEA) based efficiency indicator of 28 observed commercial banks for 2002-03 to 2004-05.
The results showed that the observed private sector commercial banks had higher mean technical efficiency score compared to those of the public sector commercial banks. Out of the 28 observed commercial banks considered for the study, six were found to be efficient. A study of the technical efficiency scores across ownership groups revealed that the observed private sector banks had higher mean technical efficiency scores compared to their public sector counterparts. Finally, most of the observed commercial banks exhibit decreasing returns to scale for the period under observation. Toby (2008) studied the Monetary Policy, Capital Adequacy Regulation and Banking System Soundness in Nigeria The purpose of this research was two-fold.
First, the study was intended to determine the effects of bank liquidity management practices (monetary policy outcomes) on industry asset quality, measured with the proportion non-performing loans (npls) in the loans portfolio. Second, it investigated the effects of capital adequacy regulation on selected bank asset quality and efficiency measures. Relevant data were generated from the Central Bank of Nigeria (C. B. N. ) and Nigeria Deposit Insurance Corporation (N. D. I. C. ) official sources, including the balance sheets of selected Nigerian quoted banks. By the use of eight multiple regression equations, it was found that the use of the minimum liquidity ratio (MLR) is irrelevant in controlling industry NPAs.
The objective of controlling banking sector liquidity in the Nigerian industry with the MLR may rather increase industry NPAs and culminate in high risk concentrations. The cash reserve ratio (CRR) was more effective tool in controlling the level of NPAs in the industry as a whole and the distressed banks in particular. As the ratio of equity to loans advances increases, we should expect the classified loans ratio to decrease and asset quality to rise, and vice versa. Under regimes of rising equity-to-total-assets (ETA) ratio, we should expect the loan loss reserves ratio to fall, and vice versa. Basak (2009) made an attempt to examine the working and financial performance of the Urban Cooperative Banks (UCBs) that cater to the credit needs of persons of small means.
Though some UCBs had performed creditably in the recent years, a large number of them have shown discernible signs of weakness. The operational efficiency was unsatisfactory and characterized by low profitability, ever-growing Non-Performing Assets (NPAs) and relatively low capital base. The large-scale sickness in the UCBs had shaken the public confidence in cooperative banks. In this context, this study was conducted. To make the analysis simpler and presentable, the author took up the Contai Co-operative Bank Ltd. , one of the leading UCBs in West Bengal for a case study. The study was based on secondary data and other information provided by the bank in its published annual reports. The relevant data had been collected for the period from 1995-96 to 2006-07.
This data had been analyzed with the help of statistical tools like ratios, percentages, averages and trend analysis, chi-square test, and multiple regression analysis. The objective of the study was to identify and analyze the trend, progress and problems of this bank, to throw light on the problems of swelling NPAs and to offer some meaningful suggestions for improving the efficiency and effectiveness of this bank. The perusal of review of literature revealed that number of studies had been conducted regarding NPAs. But in all these studies the main focus was mainly on the impact of non performing assets on the profitability of the concerns. Its focus remained on the issues related to the operational efficiency which is unsatisfactory with the ever growing nonperforming assets.
Such areas like causes that convert the loan assets into NPAs and the remedies to control them were overlooked in the above researches. NEED OF STUDY The need of the study was to reduce the gap that was identified in the previous researches. The researches conducted earlier lay emphasis on the meaning of non performing assets and their performance. It showed that increase and decrease in non performing assets affects the performance and its cost and even affects the economies of scale. The areas like causes of NPAs and remedies to control them were ignored. Considering the ample importance of this aspect, the present study was conducted to know the existence of non performing assets in the banks and to find out the causes of their occurrence.
On the basis of such causes, this study evaluated the measures that banks were adopting to manage it. SCOPE OF STUDY The scope of the research was to know about non performing assets present in banks. It included the meaning, types, causes, remedies, RBI regulations related to NPA. The respondents of the study were limited to Amritsar city and the sample size was 50 banks. OBJECTIVES OF STUDY . The study has been undertaken in order to achieve the following objectives: ? To know the number of NPA cases faced by banks. ? To know the reasons due to which loan assets are converted into NPAs. ? To know the remedies used by banks to control NPAs To evaluate the strategies followed by banks to manage NPAs. ? To suggest appropriate strategies to control NPAs. Research methodology is a way to systematically solve the research problem. The research methodology includes the various methods and techniques for conducting a research. Marketing research is the systematic design, collection, analysis and reporting of data and finding relevant solution to a specific marketing situation or problem. I. RESEARCH DESIGN: Research is, thus, an original contribution to the existing stock of knowledge making for its advancement. The purpose of research is to discover answers through the application of scientific procedures.
This project has a specified framework for collecting data in an effective manner. Such framework is called “Research Design”. Type of Research – This research is descriptive in nature because it is regarding the knowing of causes of non performing assets prevailing in banks and financial institutions. It includes survey that is conducted in order to gather the already existing information. It even describes the remedies taken by banks and financial institutions in controlling NPAs. II. SAMPLING DESIGN: Sample Universe – Universe refers to the total of the items or units in any field of inquiry. It refers to the geographical area that is covered while conducting the research.
Universe for this project was all the banks operating in India. Sampling unit – The target population must be defined that has to be sampled. The sampling unit pertaining to this study was all the banks in Amritsar city. Sample size – This refers to number of respondents to be selected from the universe to constitute a sample. The sample size of 50 banks was taken. Sampling Technique – Convenience Sampling was used to select the sample. Convenient sampling is a non probability sampling technique that attempts to obtain a sample of convenient elements . In case of convenience sampling, the selection of sample depends upon the discretion of the interviewer.
In this project, Questionnaire Method was used for the collecting the data. With the help of this method of collecting data, a sample survey was conducted. III. DATA COLLECTION AND ANALYSIS: • Secondary sources: Secondary sources are those which are collected from the already published material. In this study secondary data was collected from books, journals and websites. • Primary Data: Primary data are those which hare collected afresh and for the first time and thus happen to be original in character. In this study primary data was collected from respondents with the help of well structured questionnaire. IV. TOOLS OF PRESENTATION: Tables and figures were used to present the data. V.
TOOLS OF ANALYSIS: The analysis was done by using percentages. LIMITATIONS OF STUDY It is said, “What is worth doing is worth doing best”. In other words a person should aim at perfection. However in real life this is not always possible. Human have to work within the limitation set by the nature and society. That is to say even though every possible effort has been made to make this project report authentic and comprehensive however many constraints were also at play. The major limitations of the study are:- ? Due to paucity of time and resources a countrywide survey was not possible. Hence only Amritsar city has been taken for the study. Since a smaller sample was chosen so it may not be a true representative of the population under study. ? The possibility of the respondent’s responses being biased cannot be ruled out. ? Most of the study was restricted to Internet and published data because of the non availability of primary data. After collecting the data the analysis of data and interpretation is done. Tabulation of data is done wherein classified data is put in the form of tables. After tabulation the analysis work is carried out using various techniques. Statement: To know whether there were non performing assets in the organization. Table 5. 1: Existence of Non Performing Assets in the Organizations |Existence of NPAs |No. f Respondents |%age of responses | |Yes |47 |94 | |No |3 |6 | |Total |50 |100 | Figure 5. 1: Existence of Non Performing Assets in the Organizations [pic] Analysis and Interpretation: It was clear from the table that out of 50 respondents majority had non performing assets in their organization. i. e. 94% banks had NPAs and 6% were without it. Statement: To know the number of cases that become NPAs every year. Table 5. 2: Percentage No. of Cases that Become NPAs No. of Cases (%) |No. of Respondents |% age of Responses | |1%-2% |18 |38. 30 | |2%-3% |19 |40. 43 | |3%-4% |4 |8. 51 | |4%-5% |2 |4. 25 | |5%&Above |4 |8. 1 | |Total |47 |100 | Figure 5. 2: Percentage No. of Cases that Become NPAs [pic] Analysis and Interpretation: It represented that out of 50 banks, 40. 43% of banks had NPAs between 2%-3%, 38. 30% had NPAs between 1%-2%, 8. 51% had between 3%-4% and 5%& above while remaining 4. 25% had between 4%-5%. Statement: To know which cases become NPAs mostly. Table 5. 3: Type of Cases Becoming NPAs |Type of Cases |No. of Respondents |% age of Responses | |Fully financed |42 |80. 7 | |Partially financed |10 |19. 23 | |Total |52 |100 | Figure 5. 3: Type of Cases Becoming NPAs [pic] Analysis and Interpretation: Most of the cases of fully financed in which the whole project is financed by the lender, were becoming NPAs i. e. 80. 77% and the remaining cases were of partially financed i. e. 19. 23%, in which some amount is provided as a loan. Statement: To know the types of lending that converts into NPAs. Table 5. : Lendings Provided by Institutions that Become NPAs |Types of lending |No. of Respondents |% age of Responses | |Personal loans |23 |28. 40 | |Housing loans |22 |27. 16 | |Motor Vehicle |13 |16. 05 | |Business Financing |11 |13. 58 | |Project Financing |7 |8. 4 | |Any Other |5 |6. 17 | |Total |81 |100 | Figure 5. 4: Lendings Provided by Institutions that Become NPAs [pic] Analysis and Interpretation: According to 28. 40% of banks, personal loans, for 27. 16% housing loans, for 16. 05% loans for motor vehicle, 13. 58% loans for business financing, 8. 64% loans for project financing were becoming NPAs. Remaining 6. 17% falls in any other categories which include loans given against Government guarantee.
Statement: To know the security/collateral required by banks against above loans. Table 5. 5: Security/Collateral Required Against Loans |Security |No. of Respondents |%age Responses | |Property |38 |54. 28 | |Fixed Deposits |16 |22. 86 | |Stock in Trade |10 |14. 29 | |Any other |6 |8. 7 | |Total |70 |100 | Figure 5. 5: Security/Collateral Required Against Loans [pic] Analysis and Interpretation: From above it was clear that 54. 28% require property for granting loans,22. 86% provide loans against fixed deposits, 14. 29% provide loans against stock and remaining 8. 57% requires other types of security for advancing loans. Statement: To know the main reasons for loan assets becoming NPAs. Table 5. 6: Reasons for Becoming NPAs |Reasons |No. of Respondents |%age of Responses | |Willful Default |20 |28. 7 | |Poor follow-up& Supervision |19 |26. 76 | |Market failure |11 |15. 49 | |High targets fixed by banks |9 |12. 68 | |Wrong lending |7 |9. 86 | |Poor legal framework |3 |4. 22 | |Any other |2 |2. 2 | |Total |71 |100 | Figure 5. 6: Reasons for Becoming NPAs [pic] Analysis and Interpretation: It is clear from above that 28. 17% considered willful default by borrowers as the main reason for the occurrence of non performing assets. For 26. 76% poor follow-up and supervision, for 15. 49% market failure, for 12. 68% high targets, for 9. 86% wrong lending, for 4. 22% poor legal framework were the reasons for loan assets becoming NPAs. Statement: To know the existence of recovery system prevailing in the organizations for the recovery of NPAs. Table 5. : Existence of Recovery System in the Organization |Recovery system |No. of Respondents |% age of Responses | |Yes |46 |97. 87 | |No |1 |2. 13 | |Total |47 |100 | Figure 5. 7: Existence of Recovery System in the Organization [pic] Analysis and Interpretation: Majority i. e. 97. 7% of the banks had recovery system in their organization for controlling NPAs while the remaining 2. 13% did not have any type of recovery system with them. Statement: To know the remedies taken by banks to control/manage NPAs. Table 5. 8: Various Remedies to Control NPAs |Remedies |No. of Respondents |% age of Responses | |Proper field investigation |31 |39. 24 | |Strict follow-up |22 |27. 85 | |Effective credit appraisal |19 |24. 5 | |Normal funding limit |0 |- | |Any other |7 |8. 86 | |Total |79 |100 | Figure 5. 8: Various Remedies to Control NPAs [pic] Analysis and Interpretation: It was clear from above that 39. 24% considered proper field investigation as effective measure in controlling NPAs. 27. 85% considered strict follow- up, 24. 05% considered effective credit appraisal as the remedies to control NPAs.
Statement: To know the performance of recovery system Table 5. 9: Performance of Working of Recovery System |Performance |No. of Respondents |% age of Responses | |Poor |2 |4. 26 | |Fair |6 |12. 77 | |Good |28 |59. 57 | |Very Good |8 |17. 2 | |Excellent |3 |6. 38 | |Total |47 |100 | Figure 5. 9: Performance of Working of Recovery System [pic] Analysis and Interpretation: It was clear from the above that 59. 57% of the banks reported the performance of their recovery system as good, for 17. 02% the recovery system was working very good. For 12. 77% the performance was not good but fair. Only 6. 38% reported the working of recovery system as excellent. Statement: To know whether long term strategy would be fruitful in controlling NPAs. Table 5. 0: Fruitfulness of Developing Long Term Strategy |Long term strategy |No. of Respondents |%age of Responses | |Yes |44 |93. 62 | |No |3 |6. 38 | |Total |47 |100 | Figure 5. 10: Fruitfulness of Developing Long Term Strategy [pic] Analysis and Interpretation: It was also clear that for majority of the banks i. e. 93. 2% long term plans will help in managing non performing assets. For the remaining 6. 38% these would not work in controlling NPAs. Statement: To know the percentage of future targets for NPAs. Table 5. 11: Future Targets for NPAs |Amount (%) |No. of Respondents |%age of Responses | |less than 1% |31 |65. 96 | |1%-2% |12 |25. 53 | |2%-3% |4 |8. 1 | |3%-4% |0 |- | |4% & above |0 |- | |Total |47 |100 | Figure 5. 11: Future Targets for NPAs [pic] Analysis and Interpretation: From the above data it was clear that for the majority 65. 96% their future targets in controlling NPAs would be less than 1%. 25. 53% of the financial institutions try to range their NPAs between 1%-2% and the remaining 8. 51% try to keep it within the limit of 2%-3%.
On the basis of this study, the most crucial points that can be highlighted were as follows: ? Out of 50, majority of the banks had non performing assets in their organization. This showed that many of the loans and advances given by banks were not recovered by them. ? Majority of the banks face less percentage of NPAs every year. This showed that out of total advances, maximum was returned to them by the borrowers. ? Majority of the fully financed cases, in which whole project is financed by banks, become NPAs. ? In maximum of the cases loans were provided against the property of a borrower and against his fixed deposits. ? Mostly the personal loans and housing loans turned into NPAs.
This showed that artificial property is shown by borrowers at the time of availing loan. ? Willful default was the main reason causing NPA. A borrower may have enough money but he may not have intention to pay the installment money. ? Poor follow-up was another main reason for NPAs. It was seen that inadequate supervision made the chances of the assets to become NPAs very high. ? In order to control non performing assets, majority of the banks had recovery system in their respective organizations. ? Although many remedies were taken by majority of the banks in controlling NPAs but proper field investigation contributed to the maximum. It helped in accurate verification of income, property of the person who want loan against it. According to majority of the banks the recovery system was working good but not excellent. ? Financial institutions consider the development of long term strategy beneficial in controlling non performing assets. ? Last but not the least many banks aimed at controlling the non performing assets less than 1%. CONCLUSION Non performing asset is a worrying factor for the banks. It is affecting the profitability of the banks by adding to the cost very badly. Though a good number of preventive moves were taken in this regards but the problem is inev