NON PERFORMING ASSETS --- A VIEW TO KILL

NON PERFORMING ASSETS – a view to kill

Introduction

The economy of a country depends on the development of the financial sector. The banking sector is an indispensable financial service sector supporting development plans through channelizing funds for the productive purpose, intermediating flow of funds from surplus to deficit units and supporting financial and economic policies of the government. NPA is the major problem faced by the banking sector in India, particularly Public sector bank as compared to the private and foreign banks.  The increasing NPA is affecting the health of the bank and its profitability. It is a double-edged sword, at one end it will cut the interest income and on the other hand, it cut down the profit through provisions.  Can NPA be eradicated totally and go to the scenario where there will not be any more NPAs? The Answer is NO. NPA will happen every now and then and how prudent we are in managing it.  That is why, whenever, we price a loan we will be adding Risk Premium to the pricing, evaluating various factors. The increasing NPAs in public sector banks are due to several factors and we can broadly classify as external and internal.

Position of NPA in banking sector in India

From the table below we understand that the NPA in Indian Banking industry is growing at a constant speed in last five years. While the new private sector bank and the Foreign bank have it under control, the NPA is growing at a Higher speed in case of Public Sector Banks, that too in the year 2015-2016 it has almost doubled. Can we presume that the NPA in New Private Sector Banks are under real control? The answer is big no. There is suppression of NPA in new private sector banks also.

GROSS AND NET NPAs OF SCHEDULED COMMERCIAL BANKS BANK GROUP-WISE -----(Amount in ₹ Billion)
Year (end-March)		Non-Performing Assets (NPAs)
	Net	Gross		Net
		Amount	As Percentage of Gross Advances	Amount	As Percentage of Net Advances
Scheduled Commercial Banks
2004-05	11156.63	593.73	5.2	217.54	2.0
2005-06	15168.11	510.97	3.3	185.43	1.2
2006-07	19812.37	504.86	2.5	201.01	1.0
2007-08	24769.36	563.09	2.3	247.30	1.0
2008-09	29999.24	683.28	2.3	315.64	1.1
2009-10	34970.92	846.98	2.4	387.23	1.1
2010-11	42987.04	979.00	2.5	417.00	1.1
2011-12	50735.59	1423.26	3.1	650.19	1.3
2012-13	58797.73	1935.09	3.2	986.09	1.7
2013-14	67352.13	2633.72	3.8	1423.83	2.1
2014-15	73881.60	3233.35	4.3	1758.41	2.4
2015-16	78964.67	6119.47	7.5	3498.20	4.4
Public Sector Banks
2004-05	8489.12	483.99	5.5	169.04	2.1
2005-06	11062.88	413.58	3.6	145.66	1.3
2006-07	14401.46	389.68	2.7	151.45	1.1
2007-08	17974.01	404.52	2.2	178.36	1.0
2008-09	22592.12	449.57	2.0	211.55	0.9
2009-10	27013.00	599.26	2.2	293.75	1.1
2010-11	33056.32	746.00	2.4	360.00	1.2
2011-12	38773.08	1172.62	3.3	592.05	1.5
2012-13	44728.45	1644.61	3.6	899.52	2.0
2013-14	51011.37	2272.64	4.4	1303.62	2.6
2014-15	54762.50	2784.68	5.0	1599.51	2.9
2015-16	55935.77	5399.56	9.3	3203.76	5.7
Old Private Sector Banks
2004-05	677.42	42.00	6.0	18.59	2.7
2005-06	829.57	37.59	4.4	13.75	1.7
2006-07	928.87	29.69	3.1	8.91	1.0
2007-08	1116.70	25.57	2.3	7.40	0.7
2008-09	1285.04	30.72	2.4	11.59	0.9
2009-10	1541.36	36.22	2.3	12.71	0.8
2010-11	1846.47	36.00	1.9	9.00	0.5
2011-12	2300.79	42.00	1.8	13.00	0.6
2012-13	2699.37	52.10	1.9	20.00	0.7
New Private Sector Banks
2004-05	1236.55	45.82	3.6	23.53	1.9
2005-06	2300.05	40.52	1.7	17.96	0.8
2006-07	3218.65	62.87	1.9	31.37	1.0
2007-08	4067.33	104.40	2.5	49.07	1.2
2008-09	4468.24	138.54	3.1	62.52	1.4
2009-10	4783.58	140.17	2.9	52.34	1.1
2010-11	6128.86	145.00	2.7	34.00	0.6
2011-12	7363.23	187.68	2.2	44.01	0.6
2012-13	8733.11	210.71	1.8	59.94	0.7
2013-14	13429.35	245.42	1.8	88.62	0.7
2014-15	15843.12	341.06	2.1	141.28	0.9
2015-16	19393.39	561.86	2.8	266.77	1.4
Foreign Banks In India
2004-05	753.54	21.92	2.8	6.39	0.8
2005-06	975.62	19.28	1.9	8.08	0.8
2006-07	1263.39	22.63	1.8	9.27	0.7
2007-08	1611.33	28.59	1.8	12.47	0.8
2008-09	1653.85	64.44	3.8	29.96	1.8
2009-10	1632.60	71.33	4.3	29.77	1.8
2010-11	1955.39	50.00	2.5	12.00	0.6
2011-12	2298.49	62.97	2.8	14.12	0.6
2012-13	2636.80	79.77	3.1	26.63	1.0
2013-14	2911.42	115.65	3.9	31.60	1.1
2014-15	3275.99	107.61	3.2	17.62	0.5
2015-16	3635.51	158.05	4.2	27.67	0.8

Let us examine the factors contributing to increasing in NPAs. The factors can be broadly classified into External and Internal

External Factor:

1.   Legal system

The Government has taken a number of initiatives such as Sarfaesi act, Debt recovery tribunal, Bankruptcy, and Insolvency act to speed up the legal process of recovery of NPAs. But the bank suffers due to the consequences of non- recovery carelessness and ineffectiveness in the process.  The Bank also does not have the data updated as regards to the borrower causing ineffectiveness in delivering of notices and enforcement of recovery under Sarfaesi act.

Further, credit score system also prevails wherein the default / or acceptableness of a borrower or company can be ascertained before entertain them for loans. Many a time, the official does not check the credit scores while processing the loans and there are incidents of non reporting the default, the data may not reflect the true position.

2.   Willful defaults

There are borrowers do have resources to pay back the loan but prefer to hold the repayment. Stringent measures need to be taken against these types of the borrowers in the recovery process. The willful defaulters are on increase due to bad precedence created by the government in mass loan waiver.

3.    Natural calamities

Natural Calamity is a measured factor creating the alarming increase of NPAs. This is happening in all sectors but more particularly in the agriculture sector. Every now and then, India is affected by natural calamities such a cyclone which causing damage due to heavy rains and drought where crops fail due to non- availability of rainwater. As Indian agriculture mainly based on monsoon rains, failure will affect the product and consequently default the loan.

4.    Project handling

The project is delayed for implementation due to

Ø  Inappropriate project handling,

Ø  ineffective management,

Ø  lack of adequate resources,

Ø  lack of advance technology,

Ø  day to day changing govt. Policies produce industrial sickness.

Therefore, the banks that finance those industries ultimately end up with a low recovery of their loans.

5.   Demand/supply

Entrepreneurs in India could not predict 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.  Further, change of policies of the government also makes it difficult in getting the continuous supply of raw materials particularly if it is an imported one.

The bank recovers the amount by selling off their assets, which covers the smallest label. Therefore the banks record the unrecovered part as NPAs and have to make provision for it.

6.    Change in Govt. policies

With every new govt., banking sector gets new policies for its operation, so it has to cope with the changing principles and policies for the regulation of the rising of NPAs. For example, the fallout of handloom sector is continuing as most of the weavers' Co-operative societies have become defunct largely due to the withdrawal of state patronage. The rehabilitation plan worked out by the Central government to renew the handloom sector has not yet been implemented, so the loans to handloom sectors are becoming NPAs. The action of Government for mass loan waiver for agriculture sector also impact the repayment of the loans by the agriculturist. The person who has repaid the loans becomes a fool as his good standing caused loss to him. Had he not paid the loan back, he would have been benefited by the loan waiver scheme. The scheme is only promoting willful defaulter.

7.   Bank Finance

The Bank also many time do not finance the project appropriately. The unilaterally reduce the quantum of the loan without understanding the implication to suit to their process.  The promoters have no option but to accept the terms of the Bank. Under financing will lead borrowings at the higher cost and eventually make the project fail.

8.   Global scenario

With the globalization process, the world becomes interdependent.  No country is working in isolation and any change the world economic and political scenario will affect the domestic industry also.  The economic slowdown is affecting the sales and thereby the profit. This makes them economically not viable and hence the loan could not be repaid by them.

9.   Change in regulations

Past 15 years, there are lots of changes were implemented for recognition of NPA and realization of Interest income. The Changes in Basel implementation reason for mounding NPAs in the Banking.

Internal Factors

a. Defective Lending process

The Banks while doing the appraisal, decided to lend based on the collaterals instead of the economic viability of the company, sustained profitability and cash generation. Unless the unit generates surplus cash, it may not be in a position to replay the Principle and Interest. Collaterals will give comfort and there are cases where the realization value of the collateral is not accessed properly by the appraisal team. The assumption viz production, sales, and competition are to be meaningful and achievable. The Character of the borrower and his past record are to be analyzed and satisfied before financing because the repayment of the loan depends on the willingness to replay. 
The banker should, therefore, take utmost care in ensuring that the enterprise or business for which a loan is sought is a sound one and the borrower is competent of carrying it out successfully, he should be a person of integrity and good character.

b. Inappropriate technology

Before computerization, all the cheques drawn by the borrower will be passed through the Official handling the loan portfolio. He will get a clear picture from the cheques whether the loan funds are used for the business purpose or diversion/investment purpose. As a result of the technology implementation, the transactions are done at various places and hence many time the relationship manager does not aware of the diversion of funds. There should be some improvement in technology to make it possible for the relationship manager to know about the use of funds all time.

c. Improper Appraisal

The appraisal should contain the strength, weakness, opportunity and threat analysis of the unit.  Due to the pressure of work, the relationship officer does not appraise the unit properly instead of forwarding the proposal submitted by the chartered accountant for sanction without adding value to it. While providing unsecured advances the banks depend more on the honesty, integrity, and financial soundness and creditworthiness of the borrower, so, banks should consider the borrowers own capital investment and the bank should collect credit information of the borrowers from, a. Bankers b. Enquiry from market/segment of trade, industry, business. c. From external credit rating agencies. Many a time the relationship manager does not understand the change in the economic/political condition affecting the borrowers' prospects.

Due to lack of training and development, the relationship officers could not read the balance sheet and profit and loss statement meaningfully. The quarterly information system, stock statements are taken for the procedural purpose only and filed without analysis.

d. Managerial deficiencies

 To achieve the targets, the banks do not carry out the Risk management process of borrower selection. Many a time, the proposals are imposed instead of selected based on merit. The basis for selection of borrowers such as the Marketability and Acceptability of the product, Safety of the funds, honesty, expertise, and integrity of the promoters etc. are not evaluated properly. The principle of keeping all the eggs in one basket is also not followed. The cross-selling has now gained more importance and the core business has not been given the importance it required. This is due to heavy incentive given to all the people including the top brass of the Bank. After sanction follow up and continuous monitoring the functioning of unit both off-site and on-site is not carried out.

Absence of regular industrial visit

The irregularities in spot visit also increase the NPAs, the absence of regular visit of bank officials to the customer point decreases the collection of interest and principals on the loan. In some cases, it has been done as a formality only.In some banks, the regular visits to the spot have been given to the outsourcing agency but the bank is unable to monitor the agency whether it carries out the job carefully and verify their reports at regular intervals.

Covering up by management:

The Top brass of the bank prefers to hide or show the NPA as performing asset in order to show a rosy picture about the health of the bank during his tenure. This is being done with an indention show that they have kept the bank in a good position to the world and to the promoters. Since action has not been taken at the appropriate time, it becomes very difficult to recover. We have seen incident os showing increased NPA and provision when there is a change in incumbency.  

What should be done now?

 NPAs leads to asset contraction for banks and create a problem in recycling the funds and also spend good time and money for the recovery. As per Basel III, the banks need to provide more capital against the risk-weighted assets. NPA, on one hand, will not contribute to the profit of the bank and on the other hand, take away the profit in the name of Provision thereby affecting capital accumulation through profit. With the increase in NPAs, Bank will restrict the credit flow affecting the economic growth

Remedies/Measures for managing NPAs

a.   The operating staff should be trained in the appraisal process, analyses of Balance sheet/ profit and loss statement and management credit portfolio.

b.   The credit monitoring system should be strengthened to catch up the early warning signals and take remedies then and there.

c.   Databank for Industry risk profile/ commercial risk has to be set up and made available for the relationship manager to use the same while appraisal of the loan.

d.   The release of loans should be on the cash flow modal as against traditional stock/ receivable statement method.

e.    Specialization in letter and spirit should be encouraged for the staff. Bank also should take care adequate staffing in their credit department.

f.    Recovery team should be strengthened for follow up/ coordination of cases under various legal actions.

g.   All loans above the certain threshold limit, a nominee of the bank should be in the management team to monitor the performance and use of funds.

h.   The government should take steps to speed up the legal process and ensure effective recovery.

i.     Top management also to be made accountable for failure large loans.

j.    The promoter should be blacklisted whatever their standing or group to which they belong and the banking facilities should be stopped for the group.

k.   Banking supervision should be delinked from RBI and the supervision corporation should closely monitor all the banks and regular intervals through an onsite/offsite audit.

l.     Politics should be away from the financial sector and financial sector to allow it to function independently.

m. The Incentive for cross-selling should be given only to the marketing person (Branch manager only) not all the people above him.

n.   There should be cooperation with all the banks so that a defaulter can not avail banking facilities from any other bank. This can be achieved only with data management and data sharing.

o.   ARCs should be encouraged and Banks may be allowed to promote their own ARCs for recovery of bad loans.

p.   The banks should know how to leave the unit  When they catch the early warning signals. ICICI bank exit from King Fisher where are all the public sector banks caught therein.

q.   The defaulting promoters should be financed again for another project because they are the responsible for the failure of the project.

Conclusion

The Financial sector should be strong for any economy to flourish and any failure in the banking sector will affect the depositors trust in the banking system and will adversely affect the economy. The topic of NPA is being talked above for years and now it is time to take stringent action to curb the NPAs and strengthen the recovery. This task cannot be achieved by Banks alone. All the stakeholders, I,e. The government, regulator, and the Banks should join together for solution and implementation. Delay will create non-performing banks only.

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http://www.indianmba.com/Faculty_Column/FC56/fc56.html

https://financetapmi.wordpress.com/2017/03/10/rising-npas-in-indian-banking-sector-causes-effects-implications-and-remedies/

https://indianmoney.com/articles/what-is-the-main-cause-for-an-increase-in-non-performing-assets-of-banks

www.rbi.org.in