FINAL PROJECT REPORT ON

NON PERFORMING ASSETS

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UNDER THE GUIDANCE OF

MR. HARWINDER SINGH

ABSTRACT
This report deals with the problem of having non-performing assets, the reasons for mounting of non-performing assets and the practices present in country for dealing with nonperforming assets. Banks are in the business of managing risk, not avoiding it.. Risk is the fundamental element that drives financial behavior. Without risk, the financial system would be vastly simplified. However, risk is omnipresent in the real world. Financial nstitutions, therefore, should manage the risk efficiently to survive in this highly uncertain world. The future of banking will undoubtedly rest on risk management dynamics. !nly those banks that have efficient risk management system will survive in the market in the long run. The effective management of credit risk is a critical component of comprehensive risk management essential for long-term success of a banking institution. "redit risk is the oldest and biggest risk that bank, by virtue of its very nature of business,

inherits. This has however, ac#uired a greater significance in the recent past for various reasons. Foremost among them is the wind of economic liberali$ation that is blowing across the globe. ndia is no e%ception to this swing towards market driven economy. &etter credit portfolio diversification enhances the prospects of the reduced concentration credit risk as empirically evidenced by direct relationship between concentration credit risk profile and '()s of banks. A banks success lies in its ability to assume and aggregate risk within tolerable and manageable limits.

METHODOLOGY
Formul !"#$ !%& 'ro(l&m (roviding credit facility to the borrower is one of the important factors as far as the banking sector is concerned. !n the basis of the analy$ed factor, felt that the important issue right now as far as the credit facilities are provided by bank is non performing assets. started knowing about the basics of the '()s and decided to study on the '()s. R&)& r*% D&)"$# The research design for this study is basically analytical because it utili$es the large number of data of the (ublic *ector &anks.

T+'& o, !%& - ! (rimary data takes much time and are also e%pensive whereas the secondary data are easy to search and are not e%pensive too. For my study have utili$ed totally the secondary data.
2

D ! Sour*& &ank of ndia

OBJECTI.E OF THE STUDY

Pr"m r+ o(/&*!"0&1 The primary ob+ective of the making report is, To know why '()s are the great challenge to the (ublic *ector &anks.

S&*o#- r+ o(/&*!"0&)1

 To understand what is 'on (erforming )ssets and what are the underlying reasons for the emergence of the '()s. To understand the impacts of '()s on the operations of the (ublic *ector &anks. To know what steps are being taken by the ndian banking sector to reduce the '()s

INDE2 Sr. No.

3 5 6 8 9 7 : ; 4 3< 33 35 36 38 39 37 3: History of ndian &anking *cheduled banking structure in ndia &ank of ndia- ntroductory What s '()(rovisioning 'orms . )sset "lassification /uidelines for )sset "lassification Write of (olicy 0ifficulties with '() Factors responsible for '() Reasons for '() 1anaging '() 1easures to recover an '() 2egal Resolutions for '() Findings and Recommendations "onclusion 2imitations &ibliography

To'"*)

P $& No.
4 36 37 55 68 6: 64 83 85 88 8: 8; 75 :6 ;< ;8 ;9

H *T!R3 !F '0 )' &)'4 '/

) bank is a financial institution that provides banking and ther financial services. &y the term bank is generally understood an institution that holds a &anking 2icenses. &anking licenses are granted by financial supervision authorities and provide rights to conduct the most fundamental banking services such as accepting deposits and making loans. There are also financial institutions that provide certain banking services without meeting the legal definition of a bank, a so-called 'on-bank. &anks are a subset of the financial services industry. The word bank is derived from the talian banca, which is derived from /erman and means bench. The terms bankrupt and 5broke5 are similarly derived from banca rotta,
5

which refers to an out of business bank, having its bench physically broken. 1oneylenders in 'orthern taly originally did business in open areas, or big open rooms, with each lender working from his own bench or table. Typically, a bank generates profits from transaction fees on financial services or the interest spread on resources it holds in trust for clients while paying them t is believed that interest on the asset. 0evelopment of banking industry in ndia followed below stated steps. 67 &anking in ndia has its origin as early as the 8edic period. the transition from money lending to banking must have occurred even before 1anu, the great Hindu 9urist, who has devoted a section of his work to deposits and advances and laid down rules relating to rates of interest. :7 &anking in ndia has an early origin where the indigenous bankers played a very important role in lending money and financing foreign trade and commerce. 0uring the days of the ;ast ndia "ompany, was the turn of the agency houses to carry on the banking business. The /eneral &ank of ndia was first 9oint *tock &ank to be established in the year 6<=>. The others which followed were the &ank Hindustan and the &engal &ank. ?7 n the first half of the 6@th century the ;ast 1adras in 6=C?. These ndia "ompany established three

banksA the &ank of &engal in 6=B@, the &ank of &ombay in 6=CB and the &ank of three banks also known as (residency banks were ndia was established amalgamated in 6@:B and a new bank, the mperial &ank of

in 6@:6. With the passing of the *tate &ank of ndia )ct in 6@DD the undertaking of the mperial &ank of ndia was taken by the newly constituted *tate &ank of ndia.

C7 The Reserve &ank of ndia which is the "entral &ank was created in 6@?D by passing Reserve &ank of ndia )ct,6@?C which was followed up with the &anking Regulations in 6@C@.These acts bestowed Reserve &ank of ndia ER& 7 with wide ranging powers for licensing , supervision and control of banks. "onsidering the proliferation of weak banks, R& compulsorily merged many of them with stronger banks in 6@>@. D7 The three decades after nationali$ation saw
6

phenomenal e%pansion in the

geographical coverage and financial spread of the banking system in the country. )s

certain rigidities and weaknesses were found to have developed in the system, during the late eighties the /overnment of ndia felt that these had to be addressed to enable the financial system to play its role in ushering in a more efficient and competitive economy. )ccordingly, a high-level committee was set up on 6C )ugust 6@@6 to e%amine all aspects relating organi$ation, functions the recommendations of "ommittee to the structure, a and procedures of the financial system. &ased on the E"hairman, *hri 1. 'arasimham7, the banking system was introduced in 6@@:-@?. The

comprehensive reform of

ob+ective of the reform measures was to ensure that the balance sheets of banks reflected their actual financial health. !ne of the important measures related to income recognition, asset classification and provisioning by banks, on the basis of ob+ective criteria was laid down by the Reserve &ank. The introduction of capital ade#uacy norms in line with international standards has been another important measure of the reforms process . "omprises balance of e%pired loans, compensation and other bonds such as 'ational Rural 0evelopment &onds and "apital nvestment &onds. )nnuity certificates are e%cluded. These represent mainly non F negotiable, non- interest bearing securities issued to nternational Financial nstitutions like nternational 1onetary Fund, )t book value. "omprises accruals under *mall *avings *cheme, (rovident Funds, nternational &ank for Reconstruction and 0evelopment

and )sian 0evelopment &ank.

*pecial 0eposits of 'on- /overnment >7 n the post-nationali$ation era, no new private sector banks were allowed to be set up. However, in 6@@?, in recognition of the need G"omparative analysis on '() of (rivate . (ublic sector &anksH to introduce greater competition which could lead to higher productivity These and efficiency of the banking system, new private sector banks were allowed to be set up in the new banks had to satisfy among re#uirements,
7

ndian banking system.

others, the following minimum

t should be registered as a public limited companyA The minimum paid-up capital should be Rs 6BB croreA The shares should be listed on the stock e%changeA The head#uarters of the bank should be preferably located in a centre which does not have the head#uarters of any other bankA and The bank will be sub+ect to prudential norms in respect of banking operations, accounting and other policies as laid down by the R& . t will have to achieve capital ade#uacy of eight per cent from the very beginning.

<7 ) high level "ommittee, under the "hairmanship of *hri 1. 'arasimham, was constituted by the /overnment of ndia in 0ecember 6@@< to review the record of implementation of financial system reforms recommended by the "F* in 6@@6 and chart the reforms necessary in the years ahead to make the banking system stronger and better e#uipped to compete effectively in international economic environment. The "ommittee has submitted its report to the /overnment in )pril 6@@=. *ome of the recommendations of the "ommittee, on prudential accounting norms, particularly in the areas of "apital )de#uacy Ratio, "lassification of /overnment guaranteed advances, provisioning re#uirements on standard been advances and more disclosures in the &alance *heets of banks have

accepted and implemented. The other recommendations are under consideration. =7 The banking industry in ndia is in a midst of transformation, thanks to the economic liberali$ation of the country, which has changed business environment in the country.0uring the pre-liberali$ation period, the industry was merely focusing on deposit mobili$ation and branch e%pansion. &ut with liberali$ation, it found many of its advances under the non-performing assets E'()7 list. 1ore importantly, the sector has become very competitive with the entry of many foreign and private sector banks .The face of banking is changing rapidly. There is no doubt
8

that

banking sector reforms have improved the profitability, productivity and efficiency

of banks, but in the days ahead banks will have to prepare themselves to face new challenges .

S*%&-ul&- ( #="#$ )!ru*!ur& "# I#-"

HISTORY
&ank of ndia was founded on <th *eptember, 6@B> by a group of eminent businessmen from 1umbai. The &ank was under private ownership and control till 9uly 6@>@ when it was nationali$ed along with 6? other banks. &eginning with one office in 1umbai, with a paid-up capital of Rs.DB lakh and DB employees, the &ank has made a rapid growth over the years and blossomed into a mighty institution with a strong national presence and si$able international operations. n business volume, the &ank occupies a premier position among the nationalised banks. The &ank has ?B:6 branches in ndia spread over all statesI union territories including 6?> speciali$ed branches. These branches are controlled through C= Jonal !ffices. There are := branchesI offices Eincluding three representative offices7 abroad. The &ank came out with its maiden public issue in 6@@< and follow on Kualified nstitutions (lacement in February :BB=. . Total number of shareholders as on ?6IB?I:BB@ is :, ?DD=@. While firmly adhering to a policy of prudence and caution, the &ank has been in the forefront of introducing various innovative services and systems. &usiness has been conducted with the successful blend of traditional values and ethics and the most modern infrastructure. The &ank has been the first among the nationali$ed banks to establish a fully computerised branch and )T1 facility at the 1ahala%mi &ranch at 1umbai way back in 6@=@. The &ank is also a Founder 1ember of *W FT in ndia. t pioneered the introduction of the Health "ode *ystem in 6@=:, for evaluatingI rating its credit portfolio. The &ankLs association with the capital market goes back to 6@:6 when it entered into an agreement with the &ombay *tock ;%change E&*;7 to manage the &*; "learing House. t is an association that has blossomed into a +oint venture with &*;, called the &! *hareholding 2td. to e%tend depository services to the stock broking community. &ank of ndia was the first ndian &ank to open a branch outside the country, at 2ondon, in 6@C>, and also the first to open a branch in ;urope, (aris in 6@<C. The &ank has si$able presence
10

abroad, with a network of := branches the international business accounts for around 6<.=:M of &ankLs total business.

11

M"))"o# > .")"o# M"))"o# 5to provide superior, proactive banking services to niche
markets globally, while providing cost-effective, responsive services to others in our role as a development bank, and in so doing, meet the re#uirements of our . stakehoder

.")"o# 5to become the bank of choice for corporates, medium

businesses and upmarket retail customers and to provide cost effective developmental banking for small business, mass market and rural markets5

12

BOARD MEMBERS OF BOI S.A.R.M. S'&*" l A))&! R&*o0&r+ M # $&m&#! Mum( " ?M "#@ Br #*%

S%r" L. J + r m # S%r" M G.Lo% #" S%r" A.C. U$r #"

13

A))!. G&#&r l M # $&r C%"&, M # $&r M # $&r

S%r" S.D. T"rm r& S%r" S.S. P !% = M")). ."-+ D&)%' #-&

O,,"*&r O,,"*&r O,,"*&r

E2ECUTI.E SUMMARY1
The 'on-(erforming )ssets E'.(.)s7 problem is one of the foremost and the most formidable problems that have shaken the entire banking industry in ndia like an earth#uake. 2ike a canker worm, it has been eating the banking system from within, since long. )nd like the dreaded ) 0*, banks have not been able to find a reliable cure for this malady. t has grown like a cancer and has infected every limb of the banking system. )t macro level, '.(.)s have chocked off the supply line of credit to the potential borrowers, thereby having a deleterious effect on capital formation and arresting the economic activity in the country. )t the micro level, the unsustainable level of '.(.)s has eroded the profitability of banks through reduced interest income and provisioning re#uirements, besides restricting the recycling of funds leading to serious asset liability mismatches. The problem of '.(.)s is not a matter of concern for the lenders alone. t is a matter of grave concern to the public as well, as bank credit is the catalyst to the economic growth of the country and any bottleneck in the smooth flow of credit, one cause for which is mounting '.(.)s, is bound to create adverse repercussions in the economy. 1ounting menace of '.(.)s has raised the cost of credit, made banks more adverse to risk and s#uee$ed genuine small and medium enterprise from accessing competitive credit and has throttled their enterprising spirits as well. The spiraling and the devastating affect of '.(.)s on the economy have made the problem of '.(.)s as issue of public debate and of national priority. Therefore, any measure or reform on this front would be inade#uate and incomprehensive, if it fails to make a dent in '.(.)s reduction and stall their growth in future, as well.

14

THE EMERGENCE OF NPA IN INDIAN BANAING > FINANCIAL INSTITUTIONS AND ITS DIMENSIONS
'on-performing )sset E'()7 has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. The positive results of the chain of measures effected under banking reforms by the /overnment of ndia and R& in terms of the two 'arasimhan "ommittee Reports in this contemporary period have been neutralised by the ill effects of this surging threat. 0espite various correctional steps administered to solve and end this problem, concrete results are eluding. t is a sweeping and all pervasive virus confronted universally on banking and financial institutions. The severity of the problem is however acutely suffered by 'ationalised &anks, followed by the *& group, and the all ndia Financial nstitutions.

NPA )! !")!"*) ") &B&*u!&- !%rou$% !%& ,olloC"#$ C +).

Failure to identify an '() as per stipulated guidelines, There were instances of NsubstandardL assets being classified as NstandardLA Wrong classification of an '(), classifying a NlossL asset as a NdoubtfulL or NsubstandardL assetA classifying a NdoubtfulL asset as a Nsub-standardL asset.

"lassifying an account of a credit customer as NsubstandardL and other accounts of the same credit customer as NstandardL, throwing prudential norms to the winds.

;ssentially arising from the wrong classification of '()s, there was a variation in the level of loan loss provisioning actually held by the bank and the level re#uired to be made. This practice can be logically e%plained as a desperate attempt on the part of the bankers, whenever ade#uate current earnings were not available to meet provisioning obligations. 0riven to desperation and impelled by the desire not to accept defeat, they have chosen to mislead and claim compliance with the provisioning norms, without actually providing. This only shows that the problem has swelled to graver dimensions. The international rating agency *tandard . (oor E* . (7 conveys the gloomiest picture, while estimating '()s of the ndian banking sector between ?DM to <BM of its total outstanding credit. 1uch of this, up to ?DM of the total banking assets, as per the rating
15

agency would be accounted as '() if rescheduling and restructuring of loans to make them good assets in the book are not taken into account. However R& has contested this dismal assessment. &ut the fact remains that the infection if left unchecked will eventually lead to what has been forecast by the rating agency. This invests an urgency to tackle this virus as a fire fighting e%ercise. ;mergence of '() as an )larming Threat to 'ationalised &anks '() is a brought forward legacy accumulated over the past three decades, when prudent norms of banking were forsaken basking by the halo of security provided by government ownership. t is not wrong to have pursued social goals, but this does not +ustify relegating banking goals and fiscal discipline to the background. &ut despite this e%travagance the malaise remained invisible to the public eyes due to the practice of not following transparent accounting standards, but keeping the balance sheets opa#ue. This artificially conveyed picture of Lall is wellL with (*&s suddenly came to an end when the lid was open with the introduction of the prudential norms of banking in the year 6@@:-@?, bringing total transparency in disclosure norms and LcleansingL the balance sheets of commercial banks for the first time in the country.

16

T%& I#-" # B #="#$ S+)!&m

ndiaOs banking sector is growing at a fast pace. ndia has become one of the most preferred banking destinations in the world. The reasons are numerous, the economy is growing at a rate of =M, &ank credit is growing at ?BM per annum and there is an evere%panding middle class of between :DB and ?BB million people Elarger than the population of the P*7 in need of financial services. )ll this enables double-digit returns on most asset classes which is not so in a ma+ority of other countries. Foreign banks in ndia achieving a return on assets ER!)7 of ?M, their keen interest in e%panding their businesses is understandable F even more so when compared with the measly 6M average R!) for the Top 6BBB banks in the world. ndian markets provide growth opportunities, which are unlikely to be matched by the mature banking markets around the world. *ome of the high growth potential areas to be looked at are, the market for *o#)um&r ,"# #*& stands at about :M-?M of /0(, compared with :DM in some ;uropean markets, the r& l &)! !& m r=&! in ndia is growing at ?BM annually and is pro+ected to touch Q DB billion by :BB=, the r&! "l *r&-"! is e%pected to cross Rs D,<B,BBB crore by :B6B from the current level of Rs 6,=@,BBB crore in :BBC-BD and huge SME )&*!or which contributes significantly to ndiaOs /0(.

17

NON-PERFORMING ASSET BACAGROUND1

I#!ro-u*!"o#1 tLs a known fact that the banks and financial institutions in ndia face the problem of swelling non-performing assets E'.(.)s7 and the issue is becoming more and more unmanageable. n order to bring the situation under control, some steps have been taken recently. The *ecuritisation and Reconstruction of Financial )ssets and ;nforcement of *ecurity nterest )ct, :BB: was passed by (arliament, which is an important step towards elimination or reduction of '.(.)s. M& #"#$ o, N.P.A)1 )n asset is classified as non-performing asset E'.(.)s7 if dues in the form of principal and interest are not paid by the borrower for a period of 6=B days. However with effect from 1arch :BBC, default status would be given to a borrower if dues are not paid for @B days. f any advance or credit facility granted by bank to a borrower becomes non-performing, then the bank will have to treat all the advancesIcredit facilities granted to that borrower as nonperforming without having any regard to the fact that there may still e%ist certain advances I credit facilities having performing status. )ction for enforcement of security interest can be initiated only if the secured asset is classified as 'on (erforming )sset. 'on (erforming )sset 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 R& .

18

I#-" # &*o#om+ #- N.P.A)1 Pndoubtedly the world economy has slowed down, recession is at its peak, globally stock markets have tumbled and business itself is getting hard to do. The ndian economy has been much affected due to high fiscal deficit, poor infrastructure facilities, sticky legal system, cutting of e%posures to emerging markets by F s, etc.

Further, international rating agencies like, *tandard . (oor have lowered ndiaLs credit rating to sub-investment grade. *uch negative aspects have often outweighed positives such as increasing fore% reserves and a manageable inflation rate. Pnder such a situation, it goes without saying that banks are no e%ception and are bound to face the heat of a global downturn. &ankers have reali$ed that unless the level of '.(.)s is reduced drastically, they will find it difficult to survive. Glo( l D&0&lo'm&#!) #- N.P.A)1 The core banking business is of mobili$ing the deposits and utili$ing it for lending to industry. 2ending business is generally encouraged because it has the effect of funds being transferred from the system to productive purposes, which results into economic growth. 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. ) #uestion that arises is how much risk can a bank afford to take- Recent happenings in the business world - ;nron, World"om, Rero%, /lobal "rossing do not give much confidence to banks. n case after case, these giant corporates became bankrupt and failed to provide investors with clearer and more complete information thereby introducing a degree of risk that many investors could neither neither anticipate nor welcome. The history of financial institutions also reveals the fact that the biggest banking failures were due to credit risk. 0ue to this, banks are restricting their lending operations to secured avenues only with ade#uate collateral on which to fall back upon in a situation of default.
19

W%+ N.P.A) % 0& (&*om& # "))u& ,or ( #=) #- ,"# #*" l "#)!"!u!"o#) "# I#-" D To start with, performance in terms of profitability is a benchmark for any business enterprise including the banking industry. However, increasing '.(.)s have a direct impact on banks profitability as legally banks are not allowed to book income on such accounts and at the same time banks are forced to make provision on such assets as per the Reserve &ank of ndia ER& 7 guidelines. )lso, with increasing deposits made by the public in the banking system, the banking industry cannot afford defaults by borrower s since '.(.)s affects the repayment capacity of banks. Further, Reserve &ank of ndia ER& 7 successfully creates e%cess li#uidity in the system through various rate cuts and banks fail to utili$e this benefit to its advantage due to the fear of burgeoning non-performing assets. T%& ,olloC"#$ r& !%& 'r"m r+ * u)&) ,or !ur#"#$ !%& **ou#!) "#!o NPA1 0iversion of funds, mostly for the e%pansionI diversification of business or for promoting associate concern. Factors internal to business like productI marketing failure, inefficient management, inappropriate technology, labour unrest "hanges in the 1acro-environment like recession in the economy, infrastructural bottlenecks etc. nade#uate controlI supervision, leading to timeIcost over-runs during pro+ect mplementation.

"hanges in /overnment policies e.g. mport duties. 0eficiencies like delay in the release of limitsI funds by banksIF s

S&*o#- r+ * u)&) r& ) ,olloC)120

 *election of the pro+ect. mplementation of the pro+ect- time over-run, cost over-run, under-financing technology involved ntention of the borrower. ndustrialI ;conomic trend.

)bsence of the up gradation of the unitI ploughing back of the profit.

21

THE PROBLEM OF NON-PERFORMING ASSETS

2iberli$ation and /lobali$ation ushered in by the government in the early @Bs have thrown open many challenges to the ndian financial sector. &anks, amongst other things, were set on a path to align their accounting standards with the nternational standards and by global players. They had to have a fresh look into their balance sheet and analy$e them critically in the light of the prudential norms of income recognition and provisioning that were stipulated by the regulator, based on 'arasimhan "ommittee recommendations. 2oans and )dvances as assets of the bank play an important part in gross earnings and net profits of banks. The share of advances in the total assets of the banks forms more than >B percent< and as such it is the backbone of banking structure. &ank lending is very crucial for it make possible the financing of agricultural, industrial and commercial activities of the country. The strength and soundness of the banking system primarily depends upon health of the advances. n other words, improvement in assets #uality is fundamental to strengthening working of banks and improving their financial viability. 1ost domestic public sector banks in the country are e%pected to completely wipeout their outstanding '()s between :BB> and :BB=. '()s are an inevitable burden on the banking industry. Hence the success of a bank depends upon methods of managing '()s and keeping them within tolerance level, of late, several institutional mechanisms have been developed in ndia to deal with '()s and there has also been tightening of legal provisions. (erhaps more importantly, effective management of '()s re#uires an appropriate internal check and balances system in a bank. n this background, this chapter is designed to give an outline of trends in '()s in ndian banking industry vis-S-vis other countries and highlight the importance of '()s management. '() is an advance where payment of interest or repayment of installment of principal Ein case of Term loans7 or both remains unpaid for a period of @B days6B

22

The issue of 'on-(erforming )ssets E'()s7 in the financial sector has been an area of concern for all economies and reduction in '()s has become synonymous to functional efficiency of financial intermediaries. From the early nineties till date, the regulators in ndia, under the general recommendations of the 'arasimhan "ommittee Reports E6 . :7, 8erma "ommittee Report, &asle 6 . : and insights and findings of scholars, have continuously provided guidelines and directives addressed at reducing '()s. ) perusal of the Reserve &ank of ndia ER& 7 circulars in this regard will give the reader a comprehensive idea about the e%tent of detail in which norms and guidelines have been formulated to arrest the growth in '()s. t started off with introduction of prudential norms and has delved into adoption of a risk based management system. The ndian financial sector has responded well and adopted the directives given, and the overall health has shown considerable improvement. )lthough '()s are a balance sheet issue of individual banks and financial institutions, it has wider macroeconomic implications and the literature, while discussing financial sector reforms, has gone into a discussion on '()s also. The reasons can be observed from the following flow diagram.

23

(resence of '()s indicates asset #uality of the balance sheet and hence future income generating prospects. This also re#uires provisioning which has implications with respect to capital ade#uacy. 0eclining capital ade#uacy adversely affects shareholder value and restricts the ability of the bankIinstitution to access the capital market for additional e#uity to enhance capital ade#uacy. f this happens for a large number of financial intermediaries, then, given that there are large inter bank transactions, there could be a domino kind of effect. 2ow capital ade#uacy will also severely affect the growth prospects of banks and institutions. With weak growth outlook and low functional efficiency, the sector as a whole will not be able to perform its role and will adversely affect the savings investment process. !nce we reali$e this, it is evident that a micro problem of a bank translates into a macro problem. With weak growth outlook and low functional efficiency, the sector as a whole will not be able to perform its role and will adversely affect the savings investment process. !nce we reali$e this, it is evident that a micro problem of a bank translates into a macro problem of the economy. "apital market development takes a back seat and /0( growth rate weakens.
24

The adverse effects of fiscal deficit loom large and a balance of payments crisis also cannot be ruled out. &anking crisis and foreign e%change crisis get interlinked.

E.OLUTION OF NPA)
n the early 'ineties (*&s were suffering from acute capital inade#uacy and many of them were depicting negative profitability. This is because the parameters set for their functioning were deficient and they did not pro+ect the paramount need for these corporate goals. ncorrect goal perception and identification led them to wrong destination *ince the <Bs, the *"&s of ndia functioned totally as captive capsule units cut off from international banking and unable to participate in the structural transformations,

25

the sweeping changes, and the new type of lending products emerging in the global banking nstitutions. The personnel lacked desired training and knowledge resources re#uired to compete with international players. *uch and other chaotic conditions in parts of the ndian &anking industry had resulted in the accumulation of assets, which were termed as non-productive in an unprecedented level 5)udit and nspections5 remained as functions under the control of the e%ecutive officers, which were not independent and were thus unable to correct the effect of serious flaws in policies and directions of the higher ups. The #uantum of credit e%tended by the (*&s increased by about 6>B times in the three decades after nationali$ation Efrom around Rs. ?BBB crore in 6@<B to Rs. C<D66? "rore in :BBC7. The &anks were not developed in terms of skills and e%pertise to regulate such stupendous growth in the volume and manage the diverse risks that emerged in the process. The need for organi$ing an effective mechanism to gather and disseminate credit information amongst the commercial banks was never felt or implemented. The archaic laws of secrecy of customers-information that was binding &ankers in ndia, disabled banks to publish names of defaulters for common knowledge of the other &anks in the system. 2ack of effective corporate management "redit management on the part of the lenders to the borrowers to secure their genuine and bonafide interests was not based on pragmatically calculated anticipated cash flows of the borrower concern, while recovery of installments of Term 2oans was not out of profits and surplus generated but through recourse to the corpus of working capital of the borrowing concerns. This eventually led to the failure of the pro+ect financed leaving idle assets. Functional inefficiency was also caused due to over-staffing, manual processing of over e%panded operations and failure to computeri$e &anks in ndia, when elsewhere throughout the world the system was to switch over to computeri$ation of operations.

26

M # $&m&#! o, NPA
This was due to show ineffective recovery of bank credit, lacuna in credit recovery system, inade#uate legal provision etc. 8arious steps have been taken by the government to recover and reduce '()s. *ome of them are. 6. !ne time settlementI "ompromised *cheme. :. 2ok adalats. ?. 0ebt Recovery Tribunals . . *ecurity . .

C. *ecuriti$ation and reconstruction of financial assets and enforcement of

27

nterest )ct :BB: D."orporate Reconstruction "ompanies > credit information on defaulters and role of credit information bureaus .

28

NPA MANAGEMENT POLICY

D&,"#"!"o# o, # NPA1A# ))&! (&*om&) #o#-'&r,orm"#$ C%&# "! *& )& !o $&#&r !& "#*om& !o !%& ( #=. A #o#-'&r,orm"#$ ))&! ?NPA@ ") -&,"#&- ) o, !"m&. The concept of specified period is reduced in a phased manner. The shortening of the period is from C #uarters in 6@@? when the concept of R)" norms was first introduced in ndia to 'r&)&#! l&0&l o, 4< - +). )ction for enforcement of security interest can be initiated only if the secured asset is classified as 'on (erforming )sset. 'on (erforming )sset 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 R& . )n amount due under any credit facility is treated as 5past due5 when it has not been paid within ?B days from the due date. 0ue to the improvement in the payment and settlement systems, recovery climate, upgradation of technology in the banking system, etc., it was decided to dispense with Lpast dueL concept, with effect from 1arch ?6, :BB6. )ccordingly, as from that date, a 'on performing asset E'()7 shell be an advance where i. ii. interest and Ior installment of principal remain overdue for a period of more than 6=B days in respect of a Term 2oan, the account remains Lout of orderL for a period of more than 6=B days, in respect of an overdraftI cash "reditE!0I""7, iii. the bill remains overdue for a period of more than 6=B days in the case of bills purchased and discounted, *r&-"! , *"l"!+ "# r&)'&*! o, C%"*% !%& F)'&*","&- '&r"o-G "#!&r&)! #-Eor "#)! lm&#!) o, 'r"#*"' l % ) r&m "#&- Fo0&r-u&G ,or

29

iv.

interest andI or installment of principal remains overdue for two harvest seasons but for a period not e%ceeding 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 6=B 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 L@B days overdueL norm for identification of '()s, form the year ending 1arch ?6, :BBC. )ccordingly, with effect form 1arch ?6, :BBC, a non-performing asset E'()7 shell be a loan or an advance whereA i. ii. interest and Ior installment of principal remain overdue for a period of more than @B days in respect of a Term 2oan, the account remains Lout of orderL for a period of more than @B days, inrespect of an overdraftI cash "reditE!0I""7, iii. the bill remains overdue for a period of more than @B days in the case of bills purchased and discounted, iv. interest andI or installment of principal remains overdue for two harvest seasons but for a period not e%ceeding 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 @B days in respect of other accounts.

HOu! o, or-&rH )n account should be treated as Lout of orderL if the outstanding balance remains continuously in e%cess of the sanctioned limitI drawing power. n case where the outstanding balance in the principal operating account is less than the sanctioned limitI drawing power, but there are no credits continuously for si% months as on the date of balance sheet or credits

30

are not enough to cover the interest debited during the same period, these account should be treated as Lout of orderL. O0&r-u& )ny amount due to the bank under any credit facility is LoverdueL if it is not paid on the due date fi%ed by the bank.

Pro0")"o# l Norm)1
&anks will be re#uired to make provisions for bad and doubtful debts on a uniform and consistent basis so that the balance sheets reflect a true picture of the financial status of the bank. The 'arsimham "ommittee has recommended the following provisioning norms Ei7 6BB per cent of loss assets or 6BB per cent of out standings for loss assetsA Eii7 6BB per cent of security shortfall for doubtful assets and :B per cent to DB per cent of the secured portionA and Eiii7 6B per cent of the total out standings for substandard assets. ) provision of 6M on standard assets is re#uired as suggested by 'arsimham "ommittee 6@@=. &anks need to have better credit appraisal systems so as to prevent '.(.)s from occurring. The most important rela%ation is that the banks have been allowed to make provisions for only ?B per cent of the 5provisioning re#uirements5 as calculated using the 'arsimham "ommittee recommendations on provisioning Ebut with the diluted asset classification7. The encouraging profits recently declared by several banks have to be seen in the light of provisions made by them. To the e%tent that provisions have not been made, the profits would be fictitious. D")*lo)ur& Norm)1 &anks should disclose in balance sheets maturity pattern of advances, deposits, investments and borrowings. )part from this, banks are also re#uired to give details of their
31

e%posure to foreign currency assets and liabilities and movement of bad loans. These disclosures were to be made for the year ending 1arch :BBB n fact, the banks must be forced to make public the nature of '.(.)s being written off. This should be done to ensure that the ta%payerOs money given to the banks, as capital is not used to write off private loans without ade#uate efforts and punishment of defaulters.

ASSET CLASSIFICATION
Cl ))","* !"o# o, A))&!)1 While new private banks are careful about their asset #uality and conse#uently have low non-performing assets E'.(.)s7, public sector banks have large '.(.)s due to wrong lending policies followed earlier and also due to government regulations that re#uire them to lend to sectors where potential of default is high. )llaying the fears that bulk of the 'on(erforming )ssets E'.(.)s7 was from priority sector, '() from priority sector constituted was lower at C> per cent than that of the corporate sector at C= per cent. 2oans and advances account for around CB per cent of the assets of *"&s. However, delayIdefault in payment of interest andIor repayment of principal has rendered a significant proportion of the loan assets non-performing. )s per R& Os prudential norms, a 'on(erforming )sset E'()7 is a credit facility in respect of which interestIinstallment has remained unpaid for more than two #uarters after it has become past due. T(ast dueU denotes grace period of one month after it has become due for payment by the borrower. R&$ul !"o#) ,or ))&! *l ))","* !"o# )ssets should be classified into four classes - *tandard, *ub-standard, 0oubtful, and 2oss assets. '.(.)s is loans on which the dues are not received for two #uarters. '.(.)s consist of assets fewer than three categories, sub-standard, doubtful and loss. R& for these classes of assets should evolve clear, uniform, and consistent definitions. The health code system earlier in use would have to be replaced. The banks should classify their assets based on weaknesses and dependency on collateral securities into four categories,
32

S! #- r- A))&!), t carries not more than the normal risk attached to the business and is not an '().

Su(-)! #- r- A))&!1 )n asset which remains as '() for a period e%ceeding :C months, where the current net worth of the borrower, guarantor or the current market value of the security charged to the bank is not enough to ensure recovery of the debt due to the bank in full. Dou(!,ul A))&!), )n '(), which continued to be so for a period e%ceeding two years E6= months, with effect from 1arch, :BB6, as recommended by 'arsimham "ommittee , 6@@=7. Lo)) A))&!)1 )n asset identified by the bank or internalI e%ternal auditors or R& inspection as loss asset, but the amount has not yet been written off wholly or partly. The banking industry has significant market inefficiencies caused by the large amounts of 'on (erforming )ssets E'.(.)s7 in bank portfolios, accumulated over several years. 0iscussions on non-performing assets have been going on for several years now. !ne of the earliest writings on '.(.)s defined them as 5assets which cannot be recycled or disposed off immediately, and which do not yield returns to the bank, e%amples of which are, !verdue and stagnant accounts, suit filed accounts, suspense accounts and miscellaneous assets, cash and bank balances with other banks, and amounts locked up in frauds5.
A))&! Cl ))","* !"o# *tandard assets *ubstandard assets Pro0")"o# r&Iu"r&m&#!) B.:DM :BMEirrespective of value of security7 33

0oubtful assets

:BM - DBM of the secured portion depending on the age of '(), and 6BBM of the unsecured portion.

2oss assets

6BBM

Gu"-&l"#&) ,or !%& *l ))","* !"o# o, ))&!) 67 "lassification of assets into above categories should be done taking into account the degree of well defined credit weaknesses and the e%tent of dependencies on collateral security for the reali$ation of dues. :.7 &anks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of '()Os especially in respect of high value of accounts . ?.7 )ccount with temporary 0eficiencies, The classification of an asset as '() should be based on the record of recovery .&ank should not classify an advance account as '() merely due to the e%istence of some deficiencies, which are temporary in nature as such as non F availability of ade#uate drawing power based on latest stock. C.7 )sset classification to be borrower F wise and not facility-wise, t 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 '() and not the particular facility or a part thereof, which has become irregular. D.7 )dvances under consortium arrangements, )sset classified of accounts under consortium should be based on the record of recovery of the individual member banks and other aspects having bearing on the recoverability of the advances.

34

>.7 )ccounts where there is erosion in the value of security can be reckoned as significant when the reali$able value of the security is less than DBpercent of the value assessed by the bank or accepted by R& at the time of last inspection, as the case may be. *uch '()s may be straightway classified under doubtful category and provisioning should be made as applicable to doubtful assets. <.7 )gricultural )dvances Ea.7 n respect of advances granted for agricultural purpose purpose where interest and I or installment of principal remains unpaid after it has become past due for two harvest seasons but for a period not e%ceeding two half years , such an advance should be treated as '(). Eb.7 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 Fterm production loan into a term or re-schedulement of the repayment period. Ec.7 n such cases of conversation or re-schedulement, the term loan as well as fresh shortterm loan may be treated as current dues and need not be classified as '(). =.7 Restructuring IRescheduling of loans, ) standard asset where the terms of the loan arrangement regarding interest and principal have been renegotiated or rescheduled after the commencement of production should be as sub-standard and should remain in such category for at least one year of satisfactory performance under the renegotiated or restructured terms. n case of substandard and doubtful assets also, rescheduling does not entitle a bank to upgrade the #uality of advances automatically unless there is satisfactory performance under the rescheduled Frenegotiated terms. @.7 ;%ceptions ,)s trading involves only buying and selling of commodities and the problems associated with manufacturing units.

35

Wr"!& O,, Pol"*+

Write !ff is resorted to in the borrowal accounts when the bank has e%hausted. all possible avenues of recovery and there are no more chances for effecting the recovery. Write !ff is of two kinds- (rudential write off and Regular Write of. The basic difference between prudential and Regular write off is that in prudential write off there is possibility of recovery at a distant future even after write off while in Regular write off is noIlittle possibility of recovery. R&$ul r Wr"!& o,, G&#&r l *o#-"!"o#)1) Regular write off will be considered on the happening of 6 and : and any of the ? to C below,6. )ccount is classified as loss )sset. :. 6BBM provision is held in such accounts as at the end of previous accounting year. ?. (rior approval for waiver of legal action including where account is already time barredItermination of suit proceedingsIwaiver of appeal, etc. C. )ll efforts for recovery have been taken to their conclusion, by means of action under *RF;)* )ct, legal action, e%ecution of decree, etc. and there is absolutely no prospect for any further recovery

36

D.

n e%ceptional cases, where the borrower has or have e%pired or their whereabouts can not be traced in spite of all efforts, and there is no security which can be reali$ed.

>. "ases where all efforts of recovery have been adopted and the remaining balance and circumstances are such that any further effort is considered cost-ineffective.

<. )s a result of a negotiated settlement in any account, where any proportion of the outstanding balance, unreali$ed interest andIor uncharged interestI charges is agreed to be written off or waived, this write off shall be effected after receipt of full compromise amount plus interest if any, as per terms of !T* approved . 'o specific approval is re#uired for this since the write off is part of compromise settlement duly approved by competent authority.

37

D",,"*ul!"&) C"!% !%& No# '&r,orm"#$ A))&!)

6.7 !wners do not receive a market return on their capital. n the worst case, if the bank fails, owners lose their assets. n modern times, this may affect a broad pool of shareholders. :.7 0epositors do not receive a market return on savings. n the worst case if the bank fails, depositors lose their assets or uninsured balance. &anks also redistribute losses to other borrowers by charging higher interest rates .2ower deposit rates and higher lending rates repress savings and financial markets, which hampers economic growth. ?.7 'on performing loans represent bad investments. '() misallocate credit from good pro+ects, which do not receive funding, to failed pro+ects. &ad investment ends up in misallocation of capital and, by e%tension, labour and natural resources. The economy performs below its production potential. C.7 'on performing loans may spill over the banking system and contract the money stock ,which may lead to economic contraction . T%") )'"llo0&r &,,&*! * # *% ##&l"J& !%rou$% "ll"Iu"-"!+ or ( #= "#)ol0&#*+K Ea7 When many borrowers fail to pay interest, banks may e%perience li#uidity shortages .These shortages can +am payments across the country. Ec7 Pndercapitali$ed banks e%ceeds the bankOs capital base.

38

F *!or) R&)'o#)"(l& ,or N.P.A)1

The dues of the banking sector are generally related to the performance of the unitIindustrial segment. n a few cases, the cause of '() has been due to internal factors Eto the bank7 such as weak appraisal or follow up of loans but more often than not, it is due to the factors such as management inefficiency of borrowing funds, obsolescence, lack of demand, non availability if inputs, environmental factors, etc. The main reasons for sickness and the factors leading to '.(.)s are as under, I#!&r# l F *!or)1 0iversion of Funds F For e%pansion, moderni$ation, setting up of new pro+ects, helping or promoting sister concerns.TimeI"ost overruns while implementing the pro+ects. &usiness failure like product failing to capture market, inefficient management, strikeIstrained labour relations, wrong technology, technical problems, product obsolescence, etc. EB!&r# l , *!or)1 Failure, non-paymentIoverdue, recession in other countries, e%ternali$ation problems, adverse e%change rate, etc. /overnment policies like e%cise, import duty changes, deregulation, pollution control orders, etc. Willful default, siphoning of funds, fraud, misappropriation, and promoterImanagement disputes, etc.

39

0eficiencies on the part of the bank, vi$, in credit appraisal, monitoring and follow up, delay in release of limits, delay in settlements paymentsIsubsidies by government bodies, etc. ;%ternal factors like raw material shortage, raw materialIinput price escalation, power shortage, industrial recession, e%cess capacity, natural calamities like floods, accidents, etc. "ontribution to '.(.)s by factors like siphoning off funds through fraudImisappropriation was less significant in comparison with other factors. ncidence of '.(.)s on account of deficiencies on the part of banks such as delay in sanction and disbursement of funds whereby borrowing units are starved of funds when in need, and delay in settlement of paymentsIsubsidies by the government bodies was on the low side in proportion to other factors. 2ack of effective co-ordination between banks and financial institution in respect of large value pro+ects does contribute to the emergence of '.(.)s even at the implementation stage. R& had, in February :BBB drawn up certain ground rules in this regard in consultation with the banks, F among banks and financial institution for implementation. *usceptibility of the sanctioning authorities to e%ternal pressure, failings of ";!s and the ineffectiveness of the board to check his ways also contributed in no small measures to the unusual build up of '.(.)s in some of the banks. !ne of the most prominent causes for '.(.)s, as often observed by R& disbursement stage. nspectors, is the slackness on the part of the credit management staff in their follow up to detect and prevent diversion of funds in the post and &) and circulated the same

40

REASONS FOR AN ASSET TURNING NPA

The various reasons, either singly or +ointly, behind an asset turning '() can be classified as follows Reasons from the economy side Reasons from the industry side Reasons from the borrowerOs side Reasons from the banking system side Reasons from the loan structuring side Reasons from the security side F collateral vs cash flow Reasons from the regulatory side From the above, it may be surprising to many that only the borrower is not always at fault. )t times, systemic faults can also adversely affect the profitability of financial intermediaries. The following discussion will clarify our position. R& )o#) ,rom !%& &*o#om+ )"-& )7 (olitical F mindset regarding paradigm, proactive, fiscally responsible Enational income accounts7

41

b7 ;conomic F growth, distribution, efficient allocation of resources *ocial F acceptability, mobility, education B 6 : d7. Technological F advances in use of T e7 2egal F ;nforceability of loan contracts f7 ;nvironmental F liberali$ation . globali$ation

c7

f loan contracts are not easily enforceable, there will naturally be a tendency to default. !pening up of the economy can render companies uncompetitive. 2ack of adaptation of T will make data processing difficult and information dissemination will be impossible. !b+ective analysis of risk would be difficult and appraisal would remain a sub+ective matter. *imilarly, directed programs of lending can be counterproductive.

R& )o#) ,rom !%& "#-u)!r+ )"-& a. /lobal competition b. "yclical downswing 6 : ? R& )o#) ,rom !%& (orroC&rG) )"-& c. *unset industry d. Fre#uent changes in regulatory norms

a. 1isconceived pro+ect b. (oor governance c. (roduct failure

42

d. nefficient management e. 0iversion of funds f. 0ormant capital market g. Regulatory changes

R& )o#) ,rom !%& ( #="#$ )+)!&m )"-& a. (arameters set for their functioning were deficient, incorrect goal identification F la$y banking 6 : b. 0irected banking and lack of freedom to choose products and pricing c. &eing une%posed to international marketing methods and products, people lacked perception and

training and knowledge resources ? d. !wnership and management were not distinguished F composition of &oard of

0irectors C D > < = @ 6B 66 R& )o#) ,rom !%& lo # )!ru*!ur"#$ )"-& a. High debt e#uity ratio
43

e. 2ack of systems and procedures F audit and inspections f. &anks lacked the ability to handle enormous growth in liabilities and assets g. 2ack of a mechanism of credit information dissemination h. 2ack of an effective +udicial system for recovery from defaulters i. "ollateral based lending leading to idle assets +. Fi%ing of price and #uantum of loans k. 2ack of an effective T system and 1 *

b. Timing of raising e#uity c. 0iscrepancy between the rate of interest charged and the realistic rate of return d. nconsistency between revenue generation and the loan repayment schedule e. 2ack of binding penal clauses and performance guarantees R& )o#) ,rom !%& )&*ur"!+ )"-& L *oll !&r l 0) * )% ,loC There is a tendency among banks and institutions to depend e%cessively on collateral for advancing of loans. While this is important, it presumes from the very beginning that the borrower would default and the security would need to be encashed for recovery of the loan. "learly, this logic is unacceptable. ;mphasis should then be on cash generation and a charge on this should be built into the loan contract through some escrow mechanism. R& )o#) ,rom !%& r&$ul !or+ )"-& Fre#uent regulatory changes can turn assets non-performing. )ccounting reason like reduction in income recognition norms from 6=B days to @B days could be one such reason. (ollution related issues could be the other reason. 0istance between two sugar mills could be a third.

M # $"#$ N.P.A)
The primary aim of any business is to make profits. Therefore, any asset created in the course of the conduct of business should generate income for the business. This applies e#ually to the business of banking. The banks the world over deal in money, by accepting
44

deposits Eliabilities7 and out of such deposits Eliabilities7 lendIcreate loans Eassets7. f for any reason such assets created do not generate income or become sticky and difficult of recovery, then the very position of the banks in repaying the deposits Eliabilities7 on the due dates would be at stake and in +eopardy. &anks with such assets portfolio would become weak and naturally such weak banks will lose the faith and confidence of the investors. With the introduction of prudential norms for income recognition, assets classification and provisioning, banks have become #uite sensitive and are taking all possible steps to strengthen their assets ac#uisition and monitoring systems. There is also a growing awareness to bring down non-performing assets as these are having adverse impact on their profitability due to de-recognition of interests as well as re#uirement of heavy loan loss provisions on such assets. Therefore it would be prudent for banks to manage their assets in such a manner that they always remain healthy, generate sufficient income and capable of repaymentIrecovery on the due dates. 1anagement of performingInon-performing assets in banks has become an Nart and scienceL and virtually Na battle of witsL between the banker and the borrower with the latter demanding write off or at least a ma+or sacrifice from the bankers side irrespective of whether he is in a position to pay or not. 1anagement of non-performing assets of the financial sector was put on fast track recently with the Pnion "abinet approving the promulgation of an ordinance to facilitate securitisation and reconstruction of financial assets.

M& )ur&) !o R&*o0&r N.P.A)

!ver the last few years ndian banking in its attempt to integrate itself with the global banking has been facing lots of hurdles in its way due to its inherent weaknesses, despite its high sounding claims and lofty achievements. !ne of the ma+or hurdles, the ndian banking is
45

facing today, is its ever-growing si$e of non-performing assets over which the top management of almost each bank is baffled. !n account of the intricacies involved in handling the '.(.)s the ticklish task of assets management of the bank has become a tight rope walk affair for the controlling heads, because a little wavering Vthis or that sideO may land the concern bank in trouble. The growing '.(.)s is a potent source of worry for the finance minister as well, because in a developing country like ours, banking is seen as an important instrument of development, while with the backbreaking '.(.)s banks have become helpless burden on the economy. N.P.A) C"!% ou!)! #-"#$ u' !o 9 *ror&1 n case of doubtful and loss assets, through the modified schemes, the banks have been directed to follow up a settlement formula under which the minimum amount to be recovered, amounts to be entire outstanding running ledger balances as on the date the account was identified as '() i.e. the date from which the interest was not charged to the running ledger, an analysis of the given formula shows that R& has been very much generous in granting huge rela%ation to the borrowers who were not coming forward for setting their overdue loans due to one or other reason. The scheme is of high practical value as it protects the borrowers who were having genuine problems in clearing their dues because the interest component constituted a multiplied amount of principal outstanding. !n the other hand, the concerned banks were also finding in difficult to sacrifice the entire interest component, but outstanding in the dummy ledger. 'ow as per the provision to the scheme, they will be ready to grant such rela%ation in favour of the borrowers. These guidelines have come as a windfall for borrowers who after a lot of negotiations were almost ready to repay back their principal as well as part of the interest component to settle their accounts, as under the modified scheme, they would be able to save the interest component. To that e%tent the concerned bank stands to lose. n the case of sub standard assets, the settlement formula as given in the modified scheme states that the minimum sum to be recovered must contain the entire running ledge outstanding balance as on the date of the account was identified as '() i.e. the date from the which interest was not charged to the running ledger W interest at the e%isting prime lending rate of the bank. )s per the modified sac scheme, the terms suggested for the payment of settlement amount '() are simple and pragmatic. )s per the terms of the scheme, the
46

settlement amount should be paid in lump sum by the borrower. However in case of the borrower is unable to repay back in a lump sum, the scheme allows sufficient breathing period to enable him to arrange the funds and clear at least :D percent of the settlement amount to be paid upfront and the remaining amount to be recovered in installments spread over a period of one year along with interest at the e%isting (2R from the date of settlement up to the date of final payment. N.P.A) C"!% ou!)! #-"#$ o0&r R). 9 *ror&)1 For recovery of '.(.)s over Rs. D crore, R& has left the matter to the concerned banks and advised that the concerned banks may formulate policy guidelines regarding their settlement and recovery. The freedom, in such cases, is given to the banks, because the attending circumstances in each case may vary from the other. Therefore it was in the right direction that adopting a generali$ed approach was not thought appropriate. n cases, where the amount involved is above Rs. D crore, R& e%pects "10 of each bank to supervise the '() personally. The "10s of the concerned banks are advised to review all such cases within a given timeframe and decide the course of action in terms of rehabilitationIrestructuring. R& also desires the submission of a #uarterly report of all '.(.)s above Rs. D crore from (*P banks. Thus by putting up the cut-off dates for the implementing of the scheme, R& desires the banks to reali$e the seriousness of the issue and gear up to sweep away the '.(.)s in one go. For commercial banks, it is a golden opportunity to clear the mess, consolidate and come out on a track leading t the path of global banking. The time given for weeding out the disastrous '.(.)s is neither too long nor too short and the banks, with proper planning and follow up can drastically reduce their '.(.)s, if they firmly resolve to do so. R& e%pects the commercial banks to follow the guidelines in letter and spirit without any discrimination or discretion as a slight dilution may +eopardi$e their interest. ) proper monitoring system is also desired to be evolved for monitoring the progress of the scheme. )s this is a rare opportunity given to the defaulting borrowers so that they can avail the chance given for the settlement of their loans. Without ade#uate publicity of the scheme the response from the defaulting borrowers may not be there to the e%pected level.

47

IMPACT ON PROFITABILITY
The enormous provisioning of '() together with the holding cost of such nonproductive assets over the years has acted as a severe drain on the profitability of the (*&s. n turn (*&s are seen as poor performers and unable to approach the market for raising additional capital. ;#uity issues of nationalised banks that have already tapped the market are now #uoted at a discount in the secondary market. !ther banks hesitate to approach the
48

market to raise new issues. This has alternatively forced (*&s to borrow heavily from the debt market to build Tier repeated Recapitalisation. '() is not merely non-remunerative. t is also cost absorbing and profit eroding. n the conte%t of severe competition in the banking industry, the weak banks are at disadvantage for leveraging the rate of interest in the deregulated market and securing remunerative business growth. The options for these banks are lost. 5The spread is the bread for the banks5. This is the margin between the cost of resources employed and the return therefrom. n other words it is gap between the return on funds deployedE nterest earned on credit and investments7 and cost of funds employedE nterest paid on deposits7. When the interest rates were directed by R& , as heretofore, there was no option for banks. &ut today in the deregulated market the banks decide their lending rates and borrowing rates. n the competitive money and capital 1arkets, inability to offer competitive market rates adds to the disadvantage of marketing and building new business. n the face of the deregulated banking industry, an ideal competitive working is reached, when the banks are able to earn ade#uate amount of non-interest income to cover their entire operating e%penses i.e. a positive burden. n that event the spread factor i.e. the difference between the gross interest income and interest cost will constitute its operating profits. Theoretically even if the bank keeps BM spread, it will still break even in terms of operating profit and not return an operating loss. The net profit is the amount of the operating profit minus the amount of provisions to be made including for ta%ation. "apital to meet capital ade#uacy norms putting severe pressure on their profit margins, else they are to seek the bounty of the "entral /overnment for

Im' *! o, NPA) o# D&0&lo'm&#! F"# #*" l I#)!"!u!"o#) H& l!%1

The efficiency of any 0evelopment Financial nstitutions is not always reflected only by the si$e of its balance sheet but by the level of return on its assets. '()s do not generate any income for 0F s but at the same time 0F s are re#uired to make provisions for such '()s from their current profits.
49

Following are the deleterious effect on the return on assets in several ways, 6 They erode current profits through provisioning re#uirements : They result in reduced interest income ? They re#uire high provisioning re#uirements affecting profits C They limit recycling of funds, set in asset- liability mismatches, etc.

AEY STRUCTURAL CHANGES

P% )"#$ ou! o, )! !u!or+ 'r&-&m'!"o# - The *2R re#uirement have been brought down from ?=.DM to :DM and "RR re#uirement from <.DBM to D.<DM. E(resently C.DM7 X D&r&$ul !"o# o, "#!&r&)! r !&) - )ll lending rates e%cept for lending to small borrowers and a part of e%port finance has been de-regulated. nterest on all deposits is determined by banks e%cept on savings deposits.
50

X C '"! l -&Iu *+ - ")R of @ M prescribed with effect from 1arch ?6, :BBB. X O!%&r 'ru-&#!" l #orm) - ncome recognition, asset classification and provisioning norms has been made applicable. The provisioning norms are more prudent, ob+ective, transparent, and uniform and designed to avoid sub+ectivity. X E#!r+ o, #&C 'r"0 !& )&*!or ( #=) - 4 new private sector banks have been set up with a view to induce greater competition and for improving operational efficiency of the banking system. "ompetition has been introduced in a controlled manner and today we have nine new private sector banks and ?> foreign banks in ndia competing with the public sector banks both in retail and corporate banking Fu#*!"o# l u!o#om+ - The minimum prescribed /overnment e#uity was brought to D6M. 'ine nationalised banks raised Rs.:=DD crores from the market during 6@@C-:BB6. &anks &oards have been given more powers in operational matters such as rationali$ation of branches, credit delivery and recruitment of staff. X D&(! R&*o0&r+ Tr"(u# l) - 55 DRT) and D 0R)Ts have already been set up and < more 0RTs will be set up during the current financial year. "omprehensive amendment in the )ct have been made to make the provisions for ad+udication, enforcement and recovery more effective.

X Tr #)' r&#*+ "# ,"# #*" l )! !&m&#!) - &anks have been advised to disclose certain key parameters such as ")R, percentage of '()s, provisions for '()s, net value of investment, Return on )ssets, profit per employee and interest income as percentage to working funds.

51

REPORTING FORMAT FOR NPA)

52

CHART FOR ASSESSING CORRECTI.E STEPS IN DIFFERENT CIRCUMSTANCES1

53

D",,&r&#! A''ro *%&) !o . lu !"o# o, N.P.A)1 '.(.)s are by-product of most financial systems and the level of '.(.)s is an indicator of the health of the financial system of an economy. 8aluation techni#ues should present the situation, which ma%imi$e the overall interest of all the concerned parties.
54

T%& (ro - o(/&*!"0&) o, !%& 0 lu !"o# ,r m&Cor= r& &))&#!" ll+, To set a sound basis for the selling bankIinstitution to finali$e the sale of assets, To provide a basis for the fair market value of the assets, To promote transparency of the valuation processes and, To comply with internationally accepted practices. The valuation of an asset or the pool of assets is a precursor to any restructuring e%ercise. A#+ 0 lu !"o# &B&r*")& )% ll !!&m'! !o --r&)) !%& ,olloC"#$ "))u&), The fair market value of the asset should represent the price at which market participants would undertake a restructuring. The transaction value should reflect the potential for income generation and return of principal, balanced against the applicable risk profile and market lending margins. The valuation framework should allow for valuation of specific assets as well as a portfolio of assets Ei.e. portfolio of loans to be ac#uired from a bank.7 n most cases, a single value will apply to each loan re#uired. For larger loans, however, an element of riskIreturn sharing with the selling bank may be considered. There are various methodologies used to value the companies or their debt. Typically, cash flows, assets or replacement values, or a combination of these, are considered when determining the value of the company or its debt. The matri% shows the risk profile of the '() based on its cash flows and collateral. )s shown, stronger the cash flows and collateral, lower the risk profile of the asset. *ome of the widely used approaches towards valuation of an '() by the valuation firms are detailed as under,

D")*ou#!&- C )% FloC) L !ne of the commonly used methods for estimating the value of the companyOs debt is the anticipated cash flow. The cash flow stream will represent the interest and principal payments e%pected to be received by the lender, primarily out of the internal cash flow generation from underlying business activities. Where the asset is a partly completed pro+ect,
55

the cash flow stream will have to take onto account whether the pro+ect will be completed and if so how it will be financed. f certain lenders decide to fund through e%tended facility, this will be taken into account the assetOs cash flow stream. ;ssentially the decision on the pro+ectOs financial viability will be determined by using an incremental cash flow analysis. 'ormally, the value of a healthy asset is computed as the discounted value of the e%pected future cash flows. However, a company is distress or an '() may have negative earnings and may be likely to incur operating losses for the ne%t few years. For such companies, the estimation of future cash flows is not so easy, as there is a strong possibility of bankruptcy. Pnder such a scenario the asset valuation is also based on sub+ective parameters. ) company under financial distress has some or all of the following characteristics, operating loss, inability to meet the debt obligations and high debt e#uity ratio. When dealing with such cases, the credit analysts need to evaluate the possibility and timing of positive financial performance of the company of infusion of additional funds and the overall macro economic environment. f the company is e%pected to improve its financial position in the future, the following discounted cash flow model may be used for the distress companiesI '.(.)s.

L"Iu"- !"o# . lu& A''ro *% L f the loan is in default with no or low e%pectations of its being services, the cash flow from li#uidation of the asset and collateral will be the primary approach rather than net present value of the cash flow. n this case, the take out of the lender is primarily by way of e%ercise of their rights on the assets and attached collateral. The li#uidation value of the company is the aggregate of the value of the assets of the company if solid at the market rates, net of transactions and legal costs. The estimation of the assets becomes #uite complicated when the assets of the company cannot be easily separated like in a steel, te%tile or petrochemical plant. f such assets are sold individually, ma+ority of the asset may not fetch a price closer to their books value. Further, when such sale is to take place at a #uick place, the value of the assets further fall down, as it is more or less e#ual to forced sale of the assets. )s a result of this forced sale, the seller has to accept a discount on the fair market value of such assets. n most cases, such a reali$ation is not able to cover even the secured debt fully and hence the valuation of the debt would be limited by this reali$ed value. This

56

approach has been widely used in countries like Thailand where a significant number of loans were secured by real estate and other marketable securities of various kinds. E r#"#$ Mo-&l n performing companies, the (I; ration of the industry or other similar companies may be used as a tool for determining the market value of the assets of company. f the debt of the company is more than its assets, then a proportionate discount may be applied to the debt. The above approach, however, cannot be used for most of the '.(.)s, as they would have negative ;(*. n such cases, the cash earning per share of the company and cash (I; ratio of the similar companies may be used to arrive at a market value of the '() debt.

C )& S'&*","* . lu !"o# Mo-&l L 0epending on case to case, various models have been evolved and used for specific re#uirements. shall discuss here one of such models to provide an insight as to how provide varied models can be from the conventional approaches. S&$m&#! !"o# "#!o (u*=&!), For a huge portfolio of small loans, different kind of approach may be used for arriving at the realistic valuation. !ne of them is categori$ing the loans in various buckets and then analy$ing a sample picked from various buckets. (ost currency crisis of late 6@@BOs in Thailand, the price of real estate had declined to abysmally low levels and ma+ority of the property-linked loans had become '.(.)s in the books of the local banks. For arriving at the appropriate valuation, they had followed the following methodology, *egmentation of the assets in various buckets. *election of a sample out of each bucket. 0etailed analysis of each sample.
57

*tatistical e%trapolation of the sample to the entire bucket. )rriving at the final range of the valuation of the portfolio.

B )") o, No# L P&r,orm"#$ A))&!)1

The basis of treating a credit facility as '.(.)s is as detailed below, ASS !" n respect of which interest has remained past due for si% months. ! #$ %&A' L nclusive of unpaid interest, when the installments is overdue for more than si% monthsIon which interest amount remained past due for si% months.
58

B(%% L Which remains overdue for si% months. &!) # *+## '! ASS !S F The interest in respect of a debtIincome on a receivable in the nature of short-term loansIadvances, which remains overdue for a period of si% months. SA% &, ASS !S-S #.(* # '/ # / F )ny dues on account of theseIreimbursement of e%penses rendered, which remained overdue for a period of si% months. % AS # '!A%-)(# 0+#*)AS ('S!A%$ !S F The installments, which has

become overdue for a period of more than twelve months. &!) # *# /(! ,A*(%(! S F The balance outstanding including interest accrued made available to the borrowerIbeneficiary in the same capacity when any of the credit facilities become '.(.)

DEBT RECO.ERY TRIBUNAL

)ny person aggrieved by any measure taken by secured creditor or his authorised officer may file an appeal to 0ebts Recovery Tribunal, within CD days from date on which such measure was taken. i.e. action of taking possession of asset, takeover of management of business of borrower, appointing person to manage secured asset etc. is taken by the creditor.
59

When a borrower files an appeal, the appeal cannot be entertained unlessA the borrower deposits <DM of the amount claimed in the notice by secured creditor. The 0RT can waive or reduce the amount re#uired to be deposited. The amount is not re#uired to be deposited at the time of filing appeal, but appeal will not be heard till the amount is deposited. The borrower while filing the appeal should also file an application re#uesting the 0ebt Recovery Tribunal to admit the appeal without deposit of any amount. t the 0RT orders partial deposit of the amount and the same is not deposited, appeal can be dismissed. The <DM deposit is only re#uired if the appeal is filed by the borrower. f some other aggrieved person Ee.g. guarantor, shareholder7 files it the deposit is not re#uired.

DEBT RECO.ERY APPELATE TRIBUNAL

f a person is aggrieved by the order of the 0RT, it can file an appeal to the )ppellate Tribunal within ?B days from date of receipt of the 0RT order. f the 0RT or )ppellate Tribunal holds that possession of assets by the secured creditor was wrongful and directs the secured creditor to return asset to concerned borrower, the borrower shall be entitled to compensation and costs as may be determined by 0RT or )ppellate tribunal. The Tribunal can also direct return of asset, if the secured creditor had already sold or transferred the asset to a third party. n liberali$ing economy banking and financial sector get high priority. ndian banking sector of having a serious problem due non performing. The earning capacity and profitability of the bank are highly affected due to this '() is defined as an advance for which interest or repayment of principal or both remain outstanding for a period of more than two #uarters. The level of '() act as an indicator showing the bankers credit risks and efficiency of allocation of resource.

60

n liberali$ing economy banking and financial sector get high priority. ndian banking sector of having a serious problem due non performing. The financial reforms have helped largely to clean '() was around Rs. D:,BBB crores in the year :BBC. The earning capacity and profitability of the bank are highly affected due to this '() is defined as an advance for which interest or repayment of principal or both remain out standing for a period of more than two #uarters. The level of '() act as an indicator showing the bankers credit risks and efficiency of allocation of resource.

R& )o#)1
8arious studies have been conducted to analysis the reasons for '(). What ever may be complete elimination of '() is impossible. The reasons may be widely classified in two. , E67 !ver hang component E:7 ncremental component . .

!ver hang component is due to the environment reasons, business cycle etc. ncremental component may be due to internal bank management, credit policy, terms of credit etc. S!&') !o (& ! =&# u#-&r DRT rou!& 1Ea7 (rocedure &efore Filing the case before 0RT,61

 *ell pledge goods after sending reasonable notice to the borrower. ;nsure that documentsIsecurities are enforceable against

borrowersIguarantors. Eb7 (rocedure while filing the case in 0RT, Recovery application should contain description of all relevant documents and securities charged to the bank. !riginal documents should be retained with the &ranch till 0RT re#uires the same. Ec7 )fter filing the case before 0RT, f the recovery application filed is complete in all respects, 0RT gives a serial numberA issues summons to borrowersIguarantors called defendants.

Ed7 ;%ecution of Recovery "ertificates, Recovery !fficer of 0RT e%ecutes Recovery "ertificates ER"s7 issued by (residing !fficer of 0RT. &ranchIJone should supply the )sset details within one month of the issuance of the R". D&)"$# !"o# o, R&$")!r r1/overnment of 'epal has to designate one officer level employee of the ga$ette third class of 'epal 9udicial *ervice to act as the Registrar of the tribunal or appellate tribunal, in order to carry out functions relating to general administration of the tribunal or appellate tribunal, sub+ect to general direction and control of such tribunal and appellate tribunal. Fu#*!"o#)M -u!"&) #- 'oC&r) o, R&$")!r r162

n addition to the functions, duties and powers mentioned elsewhere in this regulation, the functions, duties and powers of the Registrar shall be as follows. To e%amine and verify documents including petitions, notes of defense and memoranda of appeals to be filed with the tribunal or appellate tribunal and register them if they meet re#uirements or endorse them with reasons if they cannot be registered, To verify duplicate copies submitted in a case with the originals and certify them if they appear in order, and if the originals appear to have some defects, to mention such defects and get the concerned party to sign to that effect, To verify whether documents submitted along with petitions, memoranda of appeal and notes of defense are correct or not, To issue summons and get it served, To appoint days for appearance in cases, indicating reasonable reasons pursuant to law, To obtain power of attorney and get a case assumed pursuant to prevailing law, To promptly e%ecute, or cause to be e%ecuted, actions as referred to in the order made by the &ench, To have security or guarantee as per the order made by the &ench, To maintain, or cause to be maintained, updated records including registration books, To maintain personal records of employees, To safely retain orders and directions in a serial order. W% ! ") !%& 'oC&r o, D&(! R&*o0&r+ O,,"*&rD The order issued by the 0ebt Recovery !fficer shall deemed to be the order issued by the Tribunal. f any person disobeys any order given by the 0ebt Recovery !fficer, the Tribunal may institute contempt proceedings against that person under the provision of the )ct.

63

n recovering the principal and interest of a loan, the 0ebt Recovery !fficer, may follow the following procedures, n consistent with the decision of the Tribunal the 0ebt Recovery !fficer may follow the following procedures, sub+ect to the prevailing law. To take possession of, or auction, the borrowerLs other movable or immovable property whether furnished as security or not, To take possession of, or auction, the guarantorLs movable or immovable property, Where any individual is a borrower or guarantor, to arrest such individual and detain him pursuant to the prevailing law. Pr&)"-"#$ o,,"*&r1 He is the Head of the department. He has +udicial power to e%ecute the case.

LOAADALATS

The institution of 2okadalat constituted under the 2egal *ervices )uthorities )ct, 6@=< helps in resolving disputes between the parties by conciliation, mediation, compromise
64

or amicable settlement. t is known for effecting mediation and counseling between the parties and to reduce burden on the court, especially for small loans. "ases involving suit claims up to Rs. l million can be brought before the 2okadalat and every award of the 2okadalat shall be deemed to be a decree of a "ivil "ourt and no appeal can lie to any court against the award made by the 2okadalat. *everal people of particular localitiesI various social organi$ations are approaching 2okadalats which are generally presided over by two or three senior persons including retired senior civil servants, defense personnel and +udicial officers. They take up cases which are suitable for settlement of debt for certain consideration. (arties are heard and they e%plain their legal position. They are advised to reach to some settlement due to social pressure of senior bureaucrats or +udicial officers or social workers. f the compromise is arrived at, the parties to the litigation sign a statement in presence of 2okadalats which is e%pected to be filed in court to obtain a consent decree. 'ormally, if such settlement contains a clause that if the compromise is not adhered to by the parties, the suits pending in the court will proceed in accordance with the law and parties will have a right to get the decree from the court. n general, it is observed that banks do not get the full advantage of the 2okadalats. t is difficult to collect the concerned borrowers willing to go in for compromise on the day when the 2okadalat meets. n any case, we should continue our efforts to seek the help of the 2okadalat.

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ENACTMENT OF SRFAESI ACT

The 5The *ecuriti$ation and Reconstruction of Financial )ssets and ;nforcement of *ecurity nterest )ct5 E*RF);* 7 provides the formal legal basis and regulatory framework for setting up )sset Reconstruction "ompanies E)R"s7 in ndia. n addition to asset reconstruction and )R"s, the )ct deals with the following largely aspects, *ecuriti$ation and *ecuriti$ation "ompanies ;nforcement of *ecurity nterest "reation of a central registry in which all securiti$ation and asset reconstruction transactions as well as any creation of security interests has to be filed. The Reserve &ank of ndia ER& 7, the designated regulatory authority for )R"* has issued 0irections, /uidance 'otes, )pplication Form and /uidelines to &anks in )pril :BB? for regulating functioning of the proposed )R"* and these 0irectionsI /uidance 'otes cover various aspects relating to registration, operations and funding of )R"* and resolution of '()s by )R"*. The R& has also issued guidelines to banks and financial institutions on issues relating to transfer of assets to )R"*, consideration for the same and valuation of instruments issued by the )R"*. )dditionally, the "entral /overnment has issued the security enforcement rules E5;nforcement Rules57, which lays down the procedure to be followed by a secured creditor while enforcing its security interest pursuant to the )ct. The )ct permits the secured creditors Eif <DM of the secured creditors agree7 to enforce their security interest in relation to the underlying security without reference to the "ourt after giving a >B day notice to the defaulting borrower upon classification of the corresponding financial assistance as a non-performing asset.

The )ct permits the secured creditors to take any of the following measures, Take over possession of the secured assets of the borrower including right to transfer by way of lease, assignment or saleA
66

 Take over the management of the secured assets including the right to transfer by way of lease, assignment or saleA )ppoint any person as a manager of the secured asset Esuch person could be the )R" if they do not accept any pecuniary liability7A and Recover receivables of the borrower in respect of any secured asset which has been transferred.

)fter taking over possession of the secured assets, the secured creditors are re#uired to obtain valuation of the assets. These secured assets may be sold by using any of the following routes to obtain ma%imum value. &y obtaining #uotations from persons dealing in such assets or otherwise interested in buying the assetsA &y inviting tenders from the publicA &y holding public auctionsA or &y private treaty. 2enders have sei$ed collateral in some cases and while it has not yet been possible to recover value from most such sei$ures due to certain legal hurdles, lenders are now clearly in a much better bargaining position vis-a-vis defaulting borrowers than they were before the enactment of *RF);* )ct. When the legal hurdles are removed, the bargaining power of lenders is likely to improve further and one would e%pect to see a large number of '()s being resolved in #uick time, either through security enforcement or through settlements.

Pnder the *RF);* )ct )R"* can be set up under the "ompanies )ct, 6@D>. The )ct designates any person holding not less than 6BM of the paid-up e#uity capital of the )R" as a sponsor and prohibits any sponsor from holding a controlling interest in, being the
67

holding company of or being in control of the )R". The *RF);* and *RF);* RulesI /uidelines re#uire )R"* to have a minimum net-owned fund of not less than Rs. :B,BBB,BBB. Further, the 0irections re#uire that an )R" should maintain, on an ongoing basis, a minimum capital ade#uacy ratio of 6DM of its risk weighted assets. )R"* have been granted a ma%imum reali$ation time frame of five years from the date of ac#uisition of the assets.

The )ct stipulates several measures that can be undertaken by )R"s for asset reconstruction. These include, ;nforcement of security interestA Taking over or changing the management of the business of the borrowerA The sale or lease of the business of the borrowerA *ettlement of the borrowersL duesA and Restructuring or rescheduling of debt. )R"* are also permitted to act as a manager of collateral assets taken over by the lenders under security enforcement rights available to them or as a recovery agent for any bank or financial institution and to receive a fee for the discharge of these functions. They can also be appointed to act as a receiver, if appointed by any "ourt or 0RT.

68

INSTITUTION OF CDR MECHANISM

69

The R& has instituted the "orporate 0ebt Restructuring E"0R7 mechanism for resolution of '()s of viable entities facing financial difficulties. The "0R mechanism instituted in ndia is broadly along the lines of similar systems in the P4, Thailand, 4orea and 1alaysia. The ob+ective of the "0R mechanism has been to ensure timely and transparent restructuring of corporate debt outside the purview of the &oard for ndustrial and Financial Reconstruction E& FR7, 0RTs or other legal proceedings. The framework is intended to preserve viable corporate affected by certain internalIe%ternal factors and minimi$e losses to creditorsIother stakeholders through an orderly and coordinated restructuring programme. R& has issued revised guidelines in February :BB? with respect to the "0R mechanism. "orporate borrowers with borrowings from the banking system of Rs. :Bcrores and above under multiple banking arrangement are eligible under the "0R mechanism. )ccounts falling under standard, sub-standard or doubtful categories can be considered for restructuring. "0R is a non-statutory mechanism based on debtor-creditor agreement and inter-creditor agreement. Restructuring helps in aligning repayment obligations for bankers with the cash flow pro+ections as reassessed at the time of restructuring. Therefore it is critical to prepare a restructuring plan on the lines of the e%pected business plan along with pro+ected cash flows. The "0R process is being stabili$ed. "ertain revisions are envisaged with respect to the eligibility criteria Eamount of borrowings7 and time frame for restructuring. Foreign banks are not members of the "0R forum, and it is e%pected that they would be signing the agreements shortly. However they attend meetings. The first )R" to be operational in ndia- )sset Reconstruction "ompany of ndia E)R/ 27 is a member of the "0R forum. 2enders in ndia prefer to resort to "0R mechanism to avoid unnecessary delays in multiple lender arrangements and to increase transparency in the process. While in the R& guidelines it has been recommended to involve independent consultants, banks are so far resorting to their internal teams for recommending restructuring programs.

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Com'rom")& S&!!l&m&#! S*%&m&)

O#& T"m& S&!!l&m&#! S*%&m&)1'()s in all sectors, which have become doubtful or loss as on ?6st 1arch :BBB. The scheme also covers '()s classified as sub-standard as on ?6st 1arch :BBB, which have subse#uently become doubtful or loss. )ll cases on which the banks have initiated action under the *RF);* "ourtsI0RTsI& FR, sub+ect to )ct and also cases pending before decree being obtained from the consent

"ourtsI0RTsI& FR are covered. However cases of willful default, fraud and malfeasance are not covered. )s per the !T* scheme, for '()s up to Rs. 6Bcrores, the minimum amount that should be recovered should be 6BBM of the outstanding balance in the account.

N&$o!" !&- S&!!l&m&#! S*%&m&) The R& I/overnment has been encouraging banks to design and implement policies for negotiated settlements, particularly for old and unresolved '()s. The broad framework for such settlements was put in place in 9uly 6@@D. *pecific guidelines were issued in 1ay 6@@@ to public sector banks for one-time settlements of '()s of small scale sector. This scheme was valid until *eptember :BBB and enabled banks to recover Rs >.< billion from various accounts. Revised guidelines were issued in 9uly :BBB for recovery of '()s of Rs. DB million and less. These guidelines were effective until 9une :BB6 and helped banks recover Rs. :> billion.

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RECOMMENDATIONS
*tudies have shown that management of '.(.)s rather than elimination is prudent. ndiaOs growth rate and bank spreads are higher than western nations. )s a result we can support a non-$ero levels of '.(.)s, which balances the risk vis-S-vis return appropriate to the ndian conte%t. "oncerns have been raised about the relevance to ndia. ) significant percentage of the '.(.)s of the (*&s are in the priority sectors. 2oans in rural areas are difficult to collect and banks by virtue of their sheet reach are better placed to recover these loans. 2ok )dalats and debt recovery tribunals are other effective mechanism to handle this risk. )R"s should focus on borrowers. Further, there is a need for private sector and foreign participation in the )R". (rivate parties will look for active resolution of the problem and not merely regard it as a book transaction. 1oving '.(.)s to an )rc doesnOt get rid of the problem. n china, potential investors are still worried about the risks of non-enforcement of ownership rights of the assets they purchase from the )R"s. )ctions and measures have to be taken to build investors confidence. 'umerous papers have stressed the criticality of a well-developed capital market in the restructuring process. ) capital market brings li#uidity and mechanism for write off loans. Without this a bank may postpone the '() problem for fear pf capital ade#uacy problems and resort to tactics like ever greening. 1onitoring by bondholders is better as they have no motive to sustain uneconomic activity. Further the banks can manage credit risk better as it is easier to sell or securities loans and negotiate credit derivatives. ndian debt markets is relatively under developed and attention should be focused on building li#uidity and volumes.

72

Regulations must incorporate a conte%tual perspective Elike temporary cash flow problems7 and clients should be handled in a manner, which reflects true value of their assets and future potential to pay. The top management should delegate authority and back decision of this kind taken by middle level managers. This has been e%tensive in "hina, 9apan, and 4orea and has attracted international participants due to lower li#uidity risks. The resolution trust corporation has helped develop the securitisation market in )sia and has taken over around Q C>B bn as bad debts from <DB failed banks. ts highly standardi$ed products appeal a broad investor base. *ecuritisation in ndia is still in a nascent stage but the potential in the areas of 1ortgage &acked *ecurities. There is a fear that disposal through the provision of e%cessive reserves may result in a deflationary spiral. ) through provision of reserves will have no negative impact on the longterm dividends paid to the shareholders. Firstly, it helps restore credibility in the financial systems. Further, an ad+ustments mechanism can be created by which the capital gains and future profits that will result from the disposal of '.(.)s will pass back to the creditors as the ta% payers who incurred the losses today. The swift disposal of '.(.)s during the /reat 0epression in the middle of a severe current helped restore the credibility of the financial system. *ome e%perts argues that the current organi$ational competencies, regulatory framework, #uality of disclosure and incentive structure produce an inconsistent framework, which leads to an unsustainable performance level for a bank. 1acro level issues will have to be addressed in order to root out the problem. (rocesses at every stage of an assets life impact the overall #uality of the intermediation process and so a consistent set of procedures are necessary to handle the problem. There have been instances of banks e%tending credit to doubtful debtors Ewho willfully default on debt7 and getting kickbacks for the same. neffective legal mechanism and inade#uate internal control mechanism have made this problem grow #uick actions has to be taken on both counts so that both the defaulters and the authori$ing officer are punished heavily. Without this, all the mechanism suggested above may prove to be ineffective. The various resolution strategies for recovery from '()s include financial restructuring, change in management, one time settlement, merger, sale to an asset reconstruction company, securitisation of receivables and filing of legal suit. Pnder each option there are options,
73

which can be e%ercised either singly or +ointly. The details under each strategy are given in the following. ;arly recognition of the problem ;arly )lert *ystem F determine threshold for proactive intervention before account becomes a '() dentify borrowers with genuine intent

Restructuring should be attempted only after an ob+ective assessment of the viability and the promoterOs intent. &anks should be convinced of a turnaround within a scheduled timeframe Timeliness and ade#uacy of response Focus on "ash flows 1anagement ;ffectiveness "onsortium I 1ultiple Financing

74

FINANCIAL RESTRUCTURING
Reschedulement of the principal repayment Reduction in the rate of interest Funding of past due interest into loan or instruments Edebt or e#uity or #uasi e#uity7 Funding of future interest Waiver of past simple interest, compound interest or li#uidated damages "onversion of loan into e#uity or #uasi-e#uity Reduction in e#uity 0ebt write-off Funds infusion by way of e#uity or debt for pro+ect completion Funds infusion for working capital purposes ;scrowing of receivables F Trust . Retention )ccount Pnder this strategy, the company is in operation, but re#uires some relief. However, along with reliefs, some additional fund infusion by the promoter should be a must. CHANGE IN MANAGEMENT "hange in the promoters
75

 nduction of professionals

ONE TIME SETTLEMENT ?OTS@ Full principal with all past interest and future interest with prepayment premium Full principal with all past interest Full principal with part interest Full principal with full or part interest converted to e#uity or #uasi e#uity instrument (art principal with the remaining part converted to some e#uity or #uasi e#uity instrument (art principal and remaining part written off MERGER WITH ANOTHER COMPANY 'ature of the industry F sunrise or sunset *ynergy issues 8aluation *hare swap ratio Ta% implications

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RECOMMENDATIONS OF THE STUDY Through R& has introduced number of measures to reduce the problem of increasing '()s of the banks such as "0R mechanism. !ne time settlement schemes, enactment of *RF);* act, etc. ) lot of measures are desired in terms of effectiveness of these measures. What we would like to suggest for reducing the evolutions of the '()s of (ublic *ector &anks are as under. E67 ;ach bank should have its own independent credit rating agency which should evaluate the financial capacity of the borrower before than credit facility. E:7 The credit rating agency should regularly evaluate the financial condition of the clients. E?7 *pecial accounts should be made of the clients where monthly loan concentration reports should be made.

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EC7 t is also wise for the banks to carryout special investigative audit of all financial and business transactions and books of accounts of the borrower company when there is possibility of the diversion of the funds and mismanagement. ED7 The banks before providing the credit facilities to the borrower company should analy$e the ma+or heads of the income and e%penditure based on the financial performance of the comparable companies in the industry to identify significant variances and seek e%planation for the same from the company management. They should also analy$e the current financial position of the ma+or assets and liabilities. E>7 &anks should evaluate the *W!T analysis of the borrowing companies i.e. how they would face the environmental threats and opportunities with the use of their strength and weakness, and what will be their possible future growth in concerned to financial and operational performance. E<7 ndependent settlement procedure should be more strict and faster and the decision made by the settlement committee should be binding both borrowers and lenders and any one of them failing to follow the decision of the settlement committee should be punished severely E=7 There should be proper monitoring of the restructured accounts because there is every possibility of the loans slipping into '()s category again. E@7 (roper training is important to the staff of the banks at the appropriate level with ongoing process. That how they should deal the problem of '()s, and what continues steps they should take to reduce the '()s. E6B7 Willful 0efault of &ank loans should be made a "riminal !ffence. E667 'o loan is to be given to a /roup whose one or the other undertaking has become a 0efaulter.

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CONCLUSION OF THE STUDY )sset #uality is one of the important parameters based on which the performance of a bank is assessed by the regulation and the public. *ome of the areas where the ndian banks identified to for better '() management like credit risk management, special investigative audit, negotiated settlement, internal checks . systems for early indication of '()s etc The response to &asel )ccord reforms world over is not uniform and spontaneous.

&asel- is known for complicated risk management models and comple% data re#uirements. &ig international banks, as those in the P*, prefer this new version, as they perceive that their superior technology and systems would make them &asel compliant and provide an edge in the competitive environment, in the form of lower regulatory capital. ndian banks do not perceive any immediate value in the new norms as they are globally insignificant players with simple and straight forward balance-sheet structures. This
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is clearly vindicated by the sample study according to which D< per cent of the e%ecutives of public sector banks are sceptical about &asel )ccord norms, particularly in respect of investment cost and the comple%ity of proposed internal rating system. )s against this, the private sector banks with supposedly more investment in technology related infrastructure are in favour of the proposals under 'ew &asel "apital )ccord as vindicated by the sample study according to which >< percent of e%ecutives of private sector banks are in-favour for 'ew &asel "apital )ccord. However, putting &asel The adoption of &asel in place is going to be far more challenging than &asel .

will boost good Risk 1anagement practices and good corporate

governance in banks. However, the cost of putting in place robust system today is viewed in an increasingly number of countries as a price worth paying to prevent such crisis. )ssuming that the banks can get over the technological and operational hurdles, switching over to &asel norms can no doubt turn the ndian banks, mainly the public sector banks, more efficient and competitive globally. This, in turn, will help strengthen the financial sector to undertake further reforms including capital account convertibility more confidently. t is reali$ed that if a resolution strategy for recovery of dues from '()s is not put in place #uickly and efficiently, these assets would deteriorate in value over time and little value would be reali$ed at the end, e%cept may be its scrap value. That is whyA asset securitisation has gained popularity among financial sector players. The literature, however, has not specifically discussed about the various resolution strategies that could be put in place for recovery from '()s, and in particular, in which situation which strategy should be adopted. The purpose of this paper is to indicate the various considerations that one has to bear in mind before $eroing on a resolution strategy. The details of the strategy would follow after that. t is important to note that it is difficult to get data from banks and institutions regarding the decision process that leads to a specific resolution strategy for a particular '(). This is so as there is no fi%ed formula on the basis of which a recovery strategy for a '() is undertaken. &road parametric guidelines can be given like vintage of plant and machinery and current market value, future revenue generating potential of the assets, e%tent of provisioning in the books of the lender, asset classification as per prudential norms, the nature of the industry etc. &ut to arrive a specific figure for a one time settlement or sale of a
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second hand asset or financial restructuring involves sub+ective elements in bargaining, the e%tent to which the borrower is conscious of hisIher social status, financial strength of the incumbent promoter etc. For e%ample it is difficult to substantiate as to why a bank, for a particular company, went it for settlement for DBM of the principal amount waiving all other dues. Two '()s of the same vintage in the same industry may be resolved in two ways. This is why, although Reserve &ank of ndia ER& 7 has given some guidelines in this regard, it has left it to the discretion of the &oard of 0irectors of a bankIinstitution to take decisions outside the guidelines of R& . To conclude with, till recent past, corporate borrowers even after defaulting continuously never had any real fear of bank taking any action to recover their dues despite the fact that their entire assets were hypothecated to the banks. This is because there was no legal )ct framed to safeguard the real interest of banks. However with the introduction of *ecuritisation )ct, :BB: banks can now issue notices to their defaulters to repay their dues or else make defaulters face hard and tough actions under the aforementioned )ct. This enables banks to get rid of sticky loans thereby improving their bottom lines. )lso a hallmark of a good business is approaching it with a fresh, new perspective and re#uires management that is fully awake, fully alive and of course fully focused on making things better. )lso, the passing of the *ecuritisation )ct, :BB: came as a bonan$a for investors in banking sector stocks that in turn resulted into an improvement in their share prices. 6. The '() is one of the biggest problems that the (ublic *ector &anks are facing today is the problem of nonperforming assets. f the proper management of the '()s is not undertaken it would hamper the business of the banks. :. n absolute terms, the last three years have seen an increase in the net '()s of :D

public sector banks by :C per cent. )ccording to the numbers, the last year it saw a 6< percent rise in the sticky assets. ?. The largest public sector lender, *& , has seen an increase in the net '()s by a whopping C6 percent in :BB<-B=.

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C. )s the global slowdown has crept into the economy, bankers feel that in more loans are going to turn bad in the coming #uarters and therefore they want R& to rela% the deadline for loan reconstruction. D. 0ue to Recession . slowdown in the ndian economy would result in emerging

'()Vs for the public sector banks from te%tiles, real estate, retail, e%ports and auto sectors. >. The R& has also been trying to take number of measures but the ratio of '()s is not decreasing of the banks. The banks must find out the measures to reduce the evolving problem of the '()s. <. The reduction of the '()s would help the banks to boost up their profits, smooth recycling of funds in the nation. This would help the nation to develop more banking branches and developing the economy by providing the better financial services to the nation. =. f the concept of '()s is taken very lightly it would be dangerous for the ndian banking sector. The '()s would destroy the current profit, interest income due to large provisions of the '()s, and would affect the smooth functioning of the recycling of the funds. @. )s a result of the '()Os owners do not receive a market return on their capital. n the worst case, if the bank fails, owners lose their assets . this may affect a broad pool of shareholders . act as a rain on (rofitability. 6B. &anks also redistribute losses to other borrowers by charging higher interest rates .2ower deposit rates and higher lending rates repress savings and financial markets, which hampers economic growth. 6:. When many borrowers fail to pay interest, banks may e%perience li#uidity shortages .These shortages can +am payments across the country and as a result non performing loans may spill over the banking system and contract the money stock, which may lead to economic contraction. 6?. &anks need to create capital reserve to write off the mounting '()Os burden. 6C. T) 1an without money is like a bird without wingsU, the Rumanian proverb insists the importance of the money. ) bank is an establishment, which deals with money. The basic
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functions of "ommercial banks are the accepting of all kinds of deposits and lending of money. n general there are several challenges confronting the commercial banks in its day to day operations. The main challenge facing the commercial banks is the disbursement of funds in #uality assets E2oans and )dvances7 or otherwise it leads to 'on-performing assets.U

LIMITATIONS OF THE STUDY The limitations that we felt in our study are, t was critical for us to gather the financial data of the every bank of the (ublic *ector &anks so the better evaluations of the performance of the banks are not possible. ;very bank submitting suit file I'() 0ata to R& under, 6. Kuarterly R& format :. "omprehensive statement a7 *haring recovery in suit filed )Ic b7 )ge wise classification of )Ic c7 *ector wise i.e. ". ", )griculture and ** etc.

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 *ince our study is based on the secondary data, the practical operations as related to the '()s are adopted by the banks are not e%ercised.

*ince there is mass banking as far as amount as well as no. of branches are so wide E0&# B #= o, I#-" ") % 0"#$ mor& !% # 6<<< (r #*%&) so it was not possible for us to cover all the banks of the ndian banking sector.

(rovision for the classification of the )ssets I '()Os are differs as per guidelines of controlling banks i.e. R& within each public sector bank . this information is not available publicly.

The R& norms for the classification of assets I '()Os are available on a pay site . not publicly available through any source.

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W&()"!&)1 http,IIwww.e#uitymaster.comIstock#uotesImystocks.asp http,IImoneyterms.co.ukIinterestYspreadI
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 http,IIeconomictimes.indiatimes.comIFeaturesITheY*undayY;TI;conomyI(riva teYbanksYstruggleYtoYmanageYtheirYnonperformingYassetsIarticleshowI?BC@<6=.cmsZwrite www.6:?eng.com http,IIwww.rupeetimes.comIe%pertsI+osephYsamsonYD.html http,IIwww.rupeetimes.comInewsIpersonalYloanIbanksYaskYrbiYtoYrela%YnpaYn ormsYforYrealYestateYsectorY6@6@.html httpII,www.rbi.org.com httpII,www.money.radiff.com httpII,www.economictimes.indiatimes.com

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