A NPA in the Indian banking industry. 2.

A strong banking system is the back bone of anyeconomy as it promotes stable and continues growth to take place. The bankingsystems of different countries however, vary vastly from each other.

India ismarked by its sizable population, wide geographical spread, diverse culture andlarge income disparities. Owing to these characteristics, the Indian Bankingsystem is significantly different from other Asian countries. In India, thebanking system consists of commercial and cooperative banks. Nearly 2/3rds ofthe house hold saving in the country are directed through the banking system.The banks in India provide approximately 90% of the commercial creditrequirement of the country.

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Thus, in an economy dominated by the bankingsector, sustained impairment due to problems on the balance sheet leads to areduction in real economic activity and could culminate eventually into aneconomic crisis.The classification of assets on a bank’s balancesheet is done under the following four heads: 1.      Standard Assets: Thistype of asset is a performing asset. The asset generates continuous income forthe bank and culminates in repayments as and when they are due. They carry anormal risk and are thus not treated as an NPA in the Indian banking industry.

2.     Sub-Standard Assets :These are all those loans as well as advances which are titled asnon-performing for a  12 month period inthe books of the bank. 3.

     Doubtful Assets: Thereare those assets which are considered as non-performing for period of more than12 months. 4.     Loss Assets: Such assetare ones which cannot be recovered. It is recognised as loss assets by eitherthe central bank or the auditors. Today, thebanking system faces a major concern of Non-Performing Assets. NPAs areconsidered the primary indicator of credit risk and thus a good indicator forthe health of the banking sector.

They are inevitable for any bank and thus thesuccess of a bank is often measured by their management of NPAs. In India, thePublic banks have shown better performance than the private banks in terms offinancial operations. However, simultaneously, they have been recording anincrease in NPAs. Increased NPAs are often an indicator or a weak creditappraisal process. They also create the need of Provisions thus bringing downthe overall profitability of the banks. There have been several legislations in India whichhave impacted NPAs. The Financial Resolution and Deposit Insurance (FRDI) Billhas been the newest attempt to attempt reducing the bad loans that the banksare saddled with. While the government has made previous attempts in thisregard, they have only been moderately successful.

A slew of legislationsincluding the Insolvency and Bankruptcy Code as well as the Securitization andReconstruction of Financial Assets and Enforcement of Security Interest Act, andthe Recovery of Debts due to Banks and Financial Institutions have beeninstituted in the past. The government also attempted to set up Debt RecoveryTribunals so as to fast-track proceedings. However the impact on improvement ofNPA has not been satisfactory. In fact over the last few years the magnitude ofthe problem has only grown. It has not manifested itself into one of theleading threats to the growth and stability on the Indian Economy. There isthus a need to analyse the cause of the growing magnitude of NPAs in the Indianbanking sector and to find methods to control the same.Due to the social banking motto of the Indianbanking system, the policy makers did not give it adequate attention until longafter the problem of bad loans found its roots. However, through the years,with adoption of several reforms in the financial sector as well as the Indianbanking system ascribing to the international banking practices the issue ofNPAs received due focus.

In India, the concept of NPA came into the ambit ofdebate and policy making after the introduction of reforms in the financialsector with the recommendations of the Report of the Committee on the FinancialSystem (Narasimham, 1991). Subsequently an appropriate accounting system wasput in place.The definition of NPAs in India has changeddramatically over time. According to the Narasimham Committee Report (1991),those assets (advances, bills discounted, overdrafts, cash credit etc.) forwhich the interest remains due for a period of four quarters (180 days) shouldbe considered as NPAs.1 Then, the abovedefined  period was reduced.

From March1995 the assets for which the interest has remained unpaid for 90 days wereconsidered as NPAs.   LiteratureReview There is a substantial body of research that is presenton the subject which is present on the subject, a review of the relevantcontent is done below: Kumar (2013)indicated NPAs to be one of the main challenges in performance of commercialbanks in the late 1990s in his study – A Comparative study of NPA of OldPrivate Sector Banks and Foreign Banks. Another study conducted by Selvarajan& Vadivalagan (2013) on Management of Non-Performing Assets in PrioritySector talk about comparing Indian Bank to Public Sector Banks (PSBs. The studyfinds that the growth of Indian Bank’s lending to Priority sector is more thanthat of the Public Sector Banks as a whole.

It indicated that Indian Bank hasnot been able to control the NPAs in the early years of the decade thus leadingto accumulation of NPAs in the decade. Bloem & Gorter (2001) have suggestedan almost predictable level of NPAs, though they say that this may vary fromyear to year. They note that NPAs are caused by an inevitably large number ofwrong economic decisions by individuals as well as plain bad luck which maymanifest itself in form of intemperate weather or sudden changes in the price ofsome products. Chatterjee C., Mukherjee J. and Das (2012) in their study onManagement of non-performing assets – a current scenario has said that banksmust make an effort to find the original reasons of a loan required by theborrower. Further the suggested that proper identification of the guarantormust be undertaken by the bank including scrutiny of his/her wealth. These arepractices part of a strong credit appraisal process to which help create astrong foundation of the loans given out thus reducing the risk of a bad debtand subsequently the generation of NPAs.

Further, Prasad G.V.B. and Veena(2011) in their study on NPAs Reduction Strategies for Commercial Banks inIndia said that NPAs have a dual impact on the assets that banks own and thusthe bank’s health. First banks have to forgo the interest that was otherwisetreated as income and second they are needed to provide provisions for NPAs,thus reducing their current profits. Balasubramaniam C.S.

(2001) addressed thefact that the level of NPAs is substantial with all banks currently. The banksmust bring down their NPAs soon and this can be achieved by throughimplementation of good credit appraisal procedures, as well as effectiveinternal control systems along with their efforts to improve asset quality intheir balance sheets. Global Comparitive Analysis ofNPA’s  Source: Banknonperforming loans to total gross loans (%), World Bank Table 2: Comparisonof NPA as percent of GDP, BRICS (World Bank)Recovery MechanismThe usual recoverymeasures taken up by governments, like issuance of notices to enforcesecurities and recovery of dues was deemed a process too time consuming by theIndian Government. Thus, so as to improve the efficienciy of the process ofrecovery of NPAs, the Indian government constituted a committee under thechairmanship of late Shri Tiwari in 1981. The ask from the committee was theexamine the methods of recovering NPAs thus give recommended, including but notlimited to, the setting up of ‘Special Tribunals’ and thus expedite therecovery process. These recommendations were later endorsed by the NarasimhamCommittee (1991) which further suggested the setting up of Asset ReconstructionFund (ARF). The committee firther suggested that if necessary the IndianGovenrment should establish this fund through a special legislation whichprocess a take-over of the NPAs from banks and financial institutions by thegovernment at a discount so as to the recover the dues owed by the primaryborrowers.

On the basis of the recommendations made by the  Tiwari and the Narasimham Committees, the DebtRecovery Tribunals were established across the country in different parts. Therewas also the establishment of An Asset Reconstruction Company. Severa effortwere made to reduce NPAs. These included, inter alia, rescheduling andrestructuring of banks, restructuring of corporate debt. There wasestablishment of Lok Adalats, Civil Courts, Debt Recovery Tribunals andcompromise settlement so as to enforce restructuring and recovery. Additionally,introduction of legal reforms was hoped to speed up recovery.

1.      SARFAESI Act Up until the SARFAESI Act was put in place the legalmechanism to recover default loans was far too cumbersome and time-consuming. Itwas thus felt, that more power should be provided in the hands of the banks andfinancial institutions to make it possible for them to sell securities torecover dues. To achieve this end, the Indian Government appointed a committeeunder the chairmanship of Shri T R Andhyarujina, senior Supreme Court advocateand former Solicitor General of India, in 1999.

Four reports were submitted bythe Committee. The first of them was related to securitisation. Based on therecommendations of this, The Securitisation and Reconstruction of FinancialAssets and Enforcement of Security Interest (SARFAESI) Act, 2002, was passed. Thisact provides enforcement of the security factor without recourse to civilsuits. It was passed to empower banks and financial institutions to realiselong term assets, manage for themselves the problem of liquidity, try and reduceasset liability mismatches and finally improve recovery by taking possession ofsecurities, selling them and reducing NPAs. The ordinance also made it possiblefor banks and financial institutions to utilise the services of ARCs/SCs to speedup the recovery of dues from defaulters and thus reduce their NPAs. The SARFAESIact also contains provisions which make it possible for the ARCs/SCs to take directpossession of the secured assets and/or of the management of the defaultingborrower companies. They did not need to resort to the time-consuming processof litigation and did not allow borrowers to take shelter under the provisionsof SICA/BIFR.

In addition to passing the SARFAESI Act, certain other legalreforms were also introduced to speed up the loan recovery process. 7 2. OtherLegal Reforms One of the important factors responsible for the ever-increasinglevel of NPAs in the Indian banking industry is the weak legal system.According to an international rating agency called FITCHIBCA, “The Indian legalsystem is sympathetic towards the borrowers and works against the banks’interest. Despite most of their loans being backed by security, banks areunable to enforce their claims on the collateral when the loans turnnon-performing, and therefore, loan recoveries have been insignificant.

“However, efforts have been made to rectify these problems through the judicialprocess as well as by enacting laws. In 1999, a standing committee under theaegis of Industrial Development Bank of India (IDBI) was constituted toinitiate a co-ordinated approach to the recovery of large NPA accounts and forinstitutionalising an arrangement between banks and financial institutions forthe systematic exchange of information in respect of large borrowers (includingdefaulters and NPAs). Moreover, as mentioned above, in 2002 the SARFAESI Actwas passed and it empowered the creditors to foreclose non-performing loans andthe underlying collateral without going through a lengthy judicial or tribunalprocess (Basu, 2005). All these efforts improved the recovery of NPAs bycommercial banks, which in turn has helped in reducing the NPA level. The totalworth of NPAs recovered through various channels was around Rs 4,039 croreduring 2003-04, which increased many fold to Rs 20,578 crore during 2004- 05.Recovery of NPA Using the new institutions and legal options, banks andfinancial institutions accelerated their recovery of NPAs.

The NPAs recoveredby scheduled commercial banks through various channels is presented in Table 3and Fig1. Between 2003-04 and 2005-06, the total cases referred to various institutionswas 93,2377 which was worth about Rs 70,226 crores. Out of this, around Rs19,075 crore was recovered. In terms of cases, the highest number (5,53,042)was referred to the Lok Adalats and the lowest (15,812) to the DRTs.

In termsof the amount involved, the DRTs recovered the highest amount of around Rs32,745 crore and Lok Adalats the least, around Rs 2,965 crore. In terms of therecovery, 58 per cent of the amount involved was recovered through one-timesettlement/compromise schemes. DRTs recovered around 29 per cent and LokAdalats recovered around 16 per cent, while 22 per cent of the amount wasrecovered under the SARFAESI Act.The intention of this dissertation is to study Non-Performingassets in the context of the Indian Economy. To achieve the same, it is imperative study theeconomic history of the NPAs in India. This would involve studying thealterations brought about by the M Narasimham committee in 1991 and the impactof the same with respect to NPAs.

The RBI’s policies are often impact byinternational practices such as the Basel norms in banking. Interpretation ofNPAs and their management in the Indian context is subject to RBI policies. Further to study the impact of policy decision onNPAs in the both private and public sector banks. In the Indian context,private and public sector banks have often taken different paths whilefunctioning in the same economy.

This research intends to study the NPA trendswithin public and private banks over time and conduct a comparative analysis betweenthe two.Finally the study intends to research upon remedialmethods for banks to reduce the NPAs and further ways to improve the health ofthe banking system in this regard. Also the study intends to researchpreventive measures and practices that banks should take on to improve thequality of assets on their balance sheets.


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