Financial sector reform in India has progressed rapidly on aspects like interest rate deregulation, reduction in reserve requirements, barriers to entry, prudential norms and risk-based supervision. But progress on the structural-institutional aspects has been much slower and is a cause for concern. The sheltering of weak institutions while liberalizing operational rules of the game is making implementation of operational changes difficult and ineffective. Changes required to tackle the NPA problem would have to span the entire gamut of judiciary, polity and the bureaucracy to be truly effective.
This paper deals with the experiences of other Asian countries in handling of NPAs. It further looks into the effect of the reforms on the level of NPAs and suggests mechanisms to handle the problem by drawing on experiences from other countries. Introduction After nationalization, the initial mandate that banks were given was to expand their branch network, increase the savings rate and extend credit to the rural and SSI sectors1. This mandate has been achieved admirably. Since the early 90’s the focus has shifted towards improving quality of assets and better risk management.
The ‘directed’ lending approach has given way to more market driven practices. The Narasimhan Committee has recommended prudential norms on income recognition, asset classification and provisioning. In a change from the past, Income recognition is now not on an accrual basis but when it is actually received. Past problems faced by banks were to a great extent attributable to this. Classification of what an NPA is has changed with tightening of prudential norms. Currently an asset is “non-performing” if interest or installments of principal due remain unpaid for more than 180 days.
Non-performing Assets: Definition: An asset becomes Non-performing when it ceases to generate income for a Bank It is also defined as credit facility in respect of which the interest and/or instalments of principal has remained ‘ past due’ for a specified period of time. The specified period of time is “ two quarters”. Past Due: 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.
With the advancement in technology and improvement in payment and settlement system, the past due concept have been dispensed off w. e. 31st march, 2002 accordingly a Non-performing Assets shall be treated as an advance where: Interest and/or instalments of principal remain overdue for a period of more than 180 days in respect of a Term Loan i. e. two quarters. The account remains ‘out of order’ for a period of more than 180 days, in respect of an Overdraft/ Cash Credit. The bill remains overdraft for a period of more than 180 days in the case of bills purchased and discounted. Interest and/or instalments 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 purposes.
Any amount to be received overdue for a period of more than 180 days in respect of other accounts. As a step forward towards international best practices and to ensure greater transparency, it has been decided to adopt the’90 days overdue norm for identification of NPA’ s from the year ending March31, 2004 accordingly a NPA shall be a loan or an advance where: Interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan, The account remains ‘out of order’ for a period of more than 90 days in the respect of an Overdraft/ Cash Credit.
The bill remains overdue for a period of more than 90 days in the case of bills purchased or discounted. Interest and/or instalments 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 purposes. Any amount to be received overdue for a period of more than 90 days in respect of other accounts. As a facilitating measure for smooth transition in 90 days norm, Banks have been advised to move over to charging of interest at monthly rates. By April1,2002.
But the date of classification of an advance as NPA should not be changed on account of charging of interest at monthly rates. Out of Order status: An account should be treated as ‘ Out of Order’ if the outstanding balance remains continuously in excess of the sanctioned limit/ drawing power. In cases 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 accounts should be treated as ‘Out of Order’.
Overdue status: 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. Asset Classification Categories of NPAs Banks are required to classify Non-performing assets further into the following three categories based on the period for which the asset has remained Nonperforming and the realisability of the dues: a) Sub-standard Assets b) Doubtful Assets c) Loss Assets a) Sub-standard Assets: 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 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. 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 uncollectable and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.
Impact of NPAs on Development Financial Institutions Health: The efficiency of any Development Financial Institutions is not always reflected only by the size of its balance sheet but by the level of return on its assets. NPAs donot generate any income for DFIs but at the same time DFIs are required to make provisions for such NPAs from their current profits. Following are the deleterious effect on the return on assets in several ways: 1 They erode current profits through provisioning requirements 2 They result in reduced interest income They require high provisioning requirements affecting profits 4 They limit recycling of funds, set in asset- liability mismatches, etc. Management of NPAs Profitability and Viability of Development Financial Institutions are directly affected by quality and performance of advances. The basic element of Sound NPA Management System is quick identification of Non-performing advances, their containment at minimum levels and ensuring that their impingement on the financials is minimum. Excessive Reliance on Collaterals has led Institutions to long drawn litigations and hence it should not be sole criteria for sanction.
Banks should manage their exposure limit to few borrower(s) and linkage should be placed with net owned funds for developing control over high leverages of borrower level. Exchange of credit information among banks would be immense help to them to avoid possible NPAs. Management Information system and Market intelligence should be utilized to their full potential. The Primary causes for turning the Accounts into NPA: Diversion of funds, mostly for the expansion/ diversification of business or for promoting associate concern.
Factors internal to business like product/ marketing failure, inefficient management, inappropriate technology, labour unrest Changes in the Macro-environment like recession in the economy, infrastructural bottlenecks etc. Inadequate control/ supervision, leading to time/cost over-runs during project implementation. Changes in Government policies eg. Import duties. Deficiencies like delay in the release of limits/ funds by banks/FIs Wilful defaults, siphoning of funds, frauds, misappropriation, promoters/management’s disputes, etc. Secondary Causes are as follows: Selection of the project.
Implementation of the project- time over-run, cost over-run, under-financing technology involved Intention of the borrower. Industrial/ Economic trend. Absence of the up gradation of the unit/ ploughing back of the profit. Securitisation Ordinance and McKinsey’s Report: Government asked McKinsey to submit a report on the funds needed to revive IFCI and suggest a course of action to get the company back into profit Zone. The recommendations are as follows: It suggested that IFCI should be divided into two companies: one with good assets and the other with bad assets.
The company with the good assets would focus on the financing mid-size companies and IPO management, syndication, project finance, receivable financing, mergers and acquisition and other fee-based activities. The asset reconstruction company ( set up with a capital of Rs 200 mn. ) will take care of the bad assets. It also suggested the transfer of bad loans worth Rs. 4000 crore to its new asset reconstruction company. Further it also suggested a capital infusion of up to Rs. 88 bn by the government and stakeholders for its revival.
How it matters with Securitisation Ordinance: The Securitisation and Reconstruction of Financial Assets and enforcement of Security Interest Ordinance, 2002 is brought up with the primary objective to speed up the process of Managing NPAs and developing securitisation market. This ordnance gives the reconstruction company the right to acquire by issuing debentures or bonds or any other security in the nature of the debenture. They can also acquire assets by entering into an agreement, with such banks or financial institutions.