Friday, August 30, 2013

Non Performing Assets (NPAs) & how it affect Banks - concept, issues & challenges

You might have come across cases where an individual or a company takes a Bank Loan and doesn’t pay back for various reasons. While he/company becomes a defaulter, Banks also tend to have their equivalent amount locked up. It makes effort for recovery and depending upon the case, a part of, entire amount or nil recovery is made. These are broadly classified as what’s called in Bank’s parlance a “Non-Performing asset (NPA)”.

Let’s examine NPA in Indian context, what it means, various degrees, its magnitude and implications.

Non-Performing Assets:

An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank. A Non-Performing Asset (NPA) is a loan or an advance where:

i.      interest and/ or instalment 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’ in respect of an Overdraft/Cash Credit (OD/CC),
iii.     the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
iv.     the instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops,
v.      the instalment of principal or interest thereon remains overdue for one crop season for long duration crops,
vi.     the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated February 1, 2006.
vii.   in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
viii.  in case of interest payments, banks should, classify an account as NPA only if the interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter.

Categories of NPAs:

Banks are required to classify nonperforming assets further into the following three categories based on the period for which the asset has remained nonperforming and the realisability of the dues:

i. Sub-standard Assets
ii. Doubtful Assets
iii. Loss Assets

Sub-standard Assets A substandard asset is one, which has remained NPA for a period less than or equal to 12 months. Such an asset will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

Doubtful Assets - An asset is classified as doubtful if it has remained in the substandard category for a period of 12 months. A loan classified as doubtful has all the weaknesses inherent in assets that were classified as substandard, 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.

Loss Assets - 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. 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. 
How a provisioning is done by Banks:
Status of NPAs
As per the data made available by the Reserve Bank of India (RBI),  Gross NPAs of the Scheduled Commercial Banks SCBs), especially Public Sector Banks (PSBs) have shown an increase during the recent years i.e.
Rs. 71,080 crore (March, 2011, GNPA ratio 2.32%), 
Rs.112,489 crore (March, 2012, GNPA ratio 3.17%), 
Rs. 1,55,890 crore (March, 2013, GNPA ratio 3.84%) and 
Rs. 1,76,009 crore (June, 2013, GNPA ratio 4.39%, provisional).
Although GNPAs have increased at system level, the GNPAs ratios of banks do not indicate systemic vulnerability. Main reasons for increase in NPAs of banks, inter-alia, are (I) switch over to System Based Identification of NPAs as against the manual compilation earlier where individual officers tended to suppress the extent, (ii) current macro-economic situation in the country, (iii) increased interest rates in the recent past, (iv) lower economic growth in 2011-12 (6.2 per cent) and   2012-13 (5.0 per cent) and (v) aggressive lending by banks in the past, especially during good times.       
The level of NPAs vary for different sectors:   (in % of gross advances)
The NPAs as percent of gross advances has come down over the years even though in absolute terms it has gone up. The first graph shows NPAs as percent of gross advances for Public Sector Banks while the second graph shows the actual NPAs (in Rs crores)
If one looks at the proportion of top 30 NPA accounts for each Bank, it amounts to 40% of the total NPAs. What it means is that its not the smaller, poor people or companies who are responsible but its these large corporates who are primarily responsible for NPAs that we have today
The present set-up provides an effective and expeditious mechanism to the banks and financial institutions to recover their dues.  A brief synopsis of the existing mechanism in this regard is given below:-
(i)     The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 – The Act empowers Banks / Financial Institutions to recover their non-performing assets without the intervention of the Court, through acquiring and disposing of the secured assets in NPA accounts with outstanding amount of Rs. 1.00 lakh and above.   
(ii) Recovery of Debts Due to Banks and Financial Institutions (DRT) Act: The Act provides setting up of Debt Recovery Tribunals (DRTs) and Debt Recovery Appellate Tribunals (DRATs) for expeditious and exclusive disposal of suits filed by banks / FIs for recovery of their dues in NPA accounts with outstanding amount of Rs. 10 lac and above.  Government has, so far, set up 33 DRTs and 5 DRATs all over the country.   
(iii) Lok Adalats:  Section 89 of the Civil Procedure Code provides resolution of disputes through ADR methods such as Arbitration, Conciliation, Lok Adalats and Mediation. Lok Adalat mechanism offers expeditious, in-expensive and mutually acceptable way of settlement of disputes.   Government has advised the public sector banks to utilize this mechanism to its fullest potential for recovery in Non-performing Assets (NPAs) cases.   
Among the various channels of recovery available to banks for dealing with bad loans, the SARFAESI Act and the Debt Recovery Tribunals (DRTs) have been the most effective in terms of amount recovered.
 Steps for recovery of NPAs
To improve the health of the financial sector, to reduce the NPAs, to improve asset quality of banks, and to prevent slippages, Reserve Bank of India (RBI) has issued instructions which stipulate that each bank-
Ø  To have a Board approved loan recovery policy.
Ø  To put in place an effective mechanism for information sharing for sanction of fresh loans/ad-hoc loans/renewal of loans to new or existing borrowers.
Ø  is required to have a robust mechanism for early detection of signs of distress including prompt restructuring in the case of all viable accounts;
Ø  to have a loan recovery policy which sets down the manner of recovery of dues, targeted level of reduction (period-wise), norms for permitted sacrifice/waiver, factors to be taken into account before considering waivers, decision levels, and reporting to higher authorities;
Ø  monitoring of write-off/waiver cases;
Ø  valuation of properties including collaterals accepted for their exposures;
Ø  taking recourse to legal mechanisms like SARFAESI Act, 2002, DRTs and Lok Adalats.
Ø  To review NPA accounts of Rs. 1 crore and above by Board of Directors and top 300 NPA accounts by Management Committee of the Board.
While Banks do provide for "write-offs" in their annual accounts to take into account for losses on account of not realizable NPAs, it has to be remembered that it comes at the cost of capitalization by an equivalent amount and thus affect the performance and financial health of the Bank directly in the long run. The answer lies in prudent lending, being in constant touch with the creditors, close monitoring and follow up on the timely action.