BFMS TERM PAPER

ON

Non-Performing Assets in Indian banks: An analysis

Submitted to:
Prof. P C Narayan
Submitted By:
Group-17
Anirban Chandra(122011)
Parul Srivastava(122059)
Barretto Maclean(122022)

On
August 19th , 2013

CONTENTS
Abstract ...................................................................................................................................................... 2
History of NPA in Indian Financial system .................................................................................................... 2
NPA- Feature and RBI guidelines ................................................................................................................. 3
Cycle .................................................................................................................................................................... 3
What is a NPA ..................................................................................................................................................... 3
NPA Identification ............................................................................................................................................... 3
Salient features of NPA-treatment according to RBI guidelines ........................................................................ 4
Classification of NPAs ........................................................................................................................................ 4
Causes of NPA ............................................................................................................................................. 4
Analysis of GDP and loan advances on NPA: ................................................................................................ 5
Data Analysis:...................................................................................................................................................... 5
Results and Interpretation: ................................................................................................................................. 6
Analysis for priority sector lending: ............................................................................................................. 7
Effect of Priority Sector lending-Data analysis .............................................................................................. 7
Results and interpretation........................................................................................................................... 9
Management of NPAs ............................................................................................................................... 10
Preventive measures: ....................................................................................................................................... 10
Corrective measures ......................................................................................................................................... 10
How NPAs impact a financial institution?................................................................................................... 11
Steps taken to handle NPA problems in India through ARCs: ...................................................................... 12
Implementation issues in NPA recovery: .................................................................................................... 12
Issues faced by ARCs ......................................................................................................................................... 13
Critical analysis of ARCs in India in comparison to global models: ............................................................... 13
Performance of Indian ARCs and other recovery channels: ......................................................................... 14
NPA systems in Asian economies ............................................................................................................... 15
Japan: ................................................................................................................................................................ 15
China: ................................................................................................................................................................ 15
Future: ..................................................................................................................................................... 17
Conclusion: ............................................................................................................................................... 17
References................................................................................................................................................ 19
Exhibits..................................................................................................................................................... 20

Page 1

ABSTRACT

Non-Performing Assets (NPAs) or Non-Performing Loans (NPLs) have substantial impact on any
countrys financial system. So it is necessary to know the statistical significance of the reasons for
NPAs, specifically GDP, the total loan advances, and priority sector lending. Along with that, a
comparison between Indian public sector banks and private sector banks on dealings in loan portfolio
shows the banks capability in handling NPAs. Though in India many safeguard mechanisms to
manage NPAs are in place like Asset Reconstruction Companies (ARCs), it is necessary to analyse
their performances and the issues faced by them. A global perspective on how other countries are
performing in handling NPAs would reflect Indias position. In future, given the possibilities of
corporate bond market and new banking licences, it is also important to analyse their effects on NPAs
for Indian financial institutions.
HISTORY OF NPA IN INDIAN FINANCIAL SYSTEM

The Indian financial system has matured a lot if we analyse it for the period of 1995-2013.
Exhibit 1 and Exhibit 2 denote the change in percentage of NPAs its distribution across sectors as
well as public and private sector banks.
The 1991 crisis hampered the heath of entire financial system and left the banks undercapitalized with
high NPAs. The restructuring of the NPAs in banking sector was done on the basis of Narasimham
committee recommendations. The methods of Income recognition, asset classification and provisioning
laxity being used were the major reasons for failure.
A lot of reforms have one into the building of a robust system starting the Narasimham committee
recommendations to promulgation of SARFESI act. From being debtor friendly in terms of loan
recovery the regulations have over time given more teeth to the creditors. This has also resulted in
banks able to dole out more loans for sustainable development. A typical loan consists of three stages.

Evaluation and assessment of proposal

Support during loan period

Exit decision and modality

Earlier sometimes banks exhibited extremes of behaviour in exhibiting these stages. Loans were
disbursed based on promoter politician nexus. In the monitoring stages banks sometimes colluded with

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individuals to classify projects as sick. Such practices were prevalent due to improper monitoring at
each stage, lack of information centralization. With the setting up of agencies like CIBIL and CRISIL,
strict measures of RBI, changing focus of banks on profits, setting up of ARCs, more information
being viable in public domain partly due to adoption of information technology the loan disbursement
process for the three steps mentioned had improved substantially .The SARFESI Act had given more
control to creditors which resulted in a change a mind-set.

The first effective step towards decreasing NPAs was to improve the loan disbursement
process itself

The second was SARFESI ordinance which gave more control to the creditors in case of NPA
loans

The third was the implementation of BASEL norms added robustness to the financial structure and
indirectly incentivized banks with low NPAs.
NPA- FEATURE AND RBI GUIDELINES
CYCLE

Payment default

Declaring NPA

NPA recovery

WHAT IS A NPA

The asset side balance sheet of the bank has a substantial component in the form of loans given out.
These assets have been classified a performing and non-performing. Any loan which is capable of
generating income for the bank is performing and when it ceases to generate that income it is declared
as non-performing. Managing NPAs is important because they directly affect the financial
performance and profitability of a bank
NPA IDENTIFICATION

A loan can be classified to a NPA when

1. If there is more than 90 days interest or principal overdue the loan is considered to be a NPA.
Exception to this is case of agricultural advances they are considered NPA if payments on loans
for short duration crops become overdue for two crop seasons and long duration crops become
overdue for two crop seasons.

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2. For an overdraft or cash credit account if the account is out of order for more than 90 days
3. In case of bills if the account remains overdue for a period of more than 90 days
4. Identification of NPAs on an on-going basis and making provisions for such in each calendar
quarter.
SALIENT FEATURES OF NPA-TREATMENT ACCORDING TO RBI GUIDELINES

1. Treatment of NPAs should be done borrower wise and not facility wise in case the borrower has
More than one facility with the bank and the whole combination to be treated as NPA even if
one single facility shows irregularity. For consortium based advance involving multiple banking
arrangements, each bank can classify the account according to its own record of recovery.
2. Agricultural loans affected by natural calamities can have some relaxations (like converting to
term loan, rescheduling the repayment period, issuing fresh loans) though the modified loan
contract would have to follow the NPA norms for agricultural advances.
3. Loans backed by central government guarantee are not treated as NPA but it cant be treated for
income recognition.
4. Project financing: Banks need to fix the commencement date for commercial operations
(DCCO) and infra and Non-infra projects are treated differently according to the DCCO and
with industrial loans the moratorium of interest period is considered while determining NPAs.
5. Possibility of Any regulatory relaxation in certain situation for certain sectors: for example in
real estate sector special regulatory treatment in loan restructuring. (RBI, RBI master circulars,
2012)
6. RBI recognizes capital market, commodity and real estate as sensitive sector.in 2012 Real estate
accounted for almost 90% of banks exposure in this sensitive sector. RBI discourages banks for
speculative involvement in real estate sector.
7. Temporary deficiencies in which the borrower is unable to repay due to certain factors like non
receipt of stock statement etc. (RBI, RBI notification, 2013)
Except these exemptions whenever a loan interest or principal overdue days exceed 90 days the loan is
classified as an NPA
CLASSIFICATION OF NPAS

Type
Standard
Substandard
Doubtful
Loss

Criteria
Payment on time
0 to 90 days
90 to 365 days
>365 days

Provisions
Zero
10%
50%
100%

CAUSES OF NPA

The main factors for explaining NPAs in financial institutions in India are as below
Internal reasons:

Inefficient management, inappropriate technology, marketing failure etc.

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Overestimation about the future

External reasons:

Recession in economy
Infrastructural problems
Price rise
Delay in sanctioned limit by banks Natural calamities

Other reasons:

During the three stages of lending process, the collusion within the promoter-politician-bank
circle
Regulation for compulsory loan advances of 40% which might be of high default risks.

ANALYSIS OF GDP AND LOAN ADVANCES ON NPA:

Table-1: Indias GDP and total loan advances by Indian SCBs

Year
2004
2005
2006
2007
2008
2009
2010
2011
2012

India
GDP(*10^8)
(current US$)
7210
8340
9490
12380
12240
13650
17100
18720
18410

Total Loan
Advances
664103.8462
884805.346
1265777.127
1650233.728
1751702.308
2102501.206
2545967.299
3024558.886
3766419.682

GDP*Loan(factor)
4788188731
7379276585
12012224937
20429893559
21440836252
28699141468
43536040818
56619742338
69339786352

NPA
61881
56796
49857
48214
52746
60930
74685
89100
130800

Source: Compiled from World Bank data and Reports on Trends in Banking in India, RBI (2003-2012)
The expectation of prosperous economy (which can be associated with GDP and GDP growth) is touted
as the reason for higher loan disbursal which in effect is expected to lead to higher level of NPAs for
Banks. From exhibit, it is evident that the GDP and Loan advances are highly correlated with R2 value
of 93.33%. Higher loan advances in expectation of higher GDP growth is expected to raise the levels of
NPAs. (Exhibit3)
DATA ANALYSIS:

We would test the dependence of NPA on GDP of India and the total loan advances made by the bank.
With their individual contribution to the gross NPA amount, as there is clear correlation between the
GDP and loan advances between themselves, we are also taking into consideration the linking effect

Page 5

between them by adding a third variable and we set up the hypothesis of NPA being explained by the
following linear equation.
NPA = A0 + A1*(X1) +A2*(X2) + A3 (X3)
X1=Loan advances made by the banks
X2=GDP of India
X3=combined linking effect of GDP and Loan Advances(X1*X2)
A0 is the intercept and A1, A2, A3 are the coefficients
RESULTS AND INTERPRETATION:

Table-2: Regression Analysis output

SUMMARY OUTPUT
Regression Statistics
Multiple R
0.994212
R Square
0.988457
Adjusted R Square 0.981531
Standard Error
3589.517
Observations
9
ANOVA
df
Regression
Residual
Total

3
5
8

SS
MS
F
Significance F
5516807714 1.84E+09 142.7232
2.9041E-05
64423162.21 12884632
5581230876
:

Coefficients Standard Error

Intercept
125442.3
9467.161199
India GDP(*10^8) (current US$) -9.84079
1.158167354
Total Loan Advances
-0.01635
0.010149879
GDP*Loan(factor)
3.56E-06
4.37433E-07

t Stat
13.25026
-8.49687
-1.61132
8.144973

P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%

4.38E-05 101106.2 149778.4 101106.2 149778.4421
0.000371 -12.818 -6.86363 -12.818 -6.863629526
0.168027 -0.04245 0.009736 -0.04245 0.009736412
0.000453 2.44E-06 4.69E-06 2.44E-06 4.68734E-06

Regression analysis of data gives us the regression equation for gross NPA with98.15 %( adjusted R2
value) of gross NPA can be explained by the equation hence the relation is statistically significant (F
value of 142.72 Significance almost zero).From the analysis it is also evident that the combined linking
effect of GDP and Loan advances(X3) has more impact (t value 8.14) on gross NPA than these factors
individually are. Hence we can say that though individually they might not show significant statistical
impact on NPA, but the combined interaction and linking effect between GDP and loan advances(X 3)
explains the NPA levels for Indian banks.

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ANALYSIS FOR PRIORITY SECTOR LENDING:

In 1989-90 priority sector target for domestic commercial banks was 40% which comprised of 18% to
agriculture, 10%to weaker sections. For foreign banks this number was 32%.This has been changed
with effect from August 2007 where the targets are now decided as 40% of Adjusted Net Bank Credit
(ANBC) or Credit Equivalent of Off-Balance sheet Exposure (CEOBE), whichever is higher. All banks
are mandated to lend 40% of their net credit to the priority sector (SSI, agriculture) at interest rate not
more than 4% above prime lending rate.
RBI has included those sectors as part of the priority sector, which impact large segments of population
& the weaker sections, and which are employment intensive.

Source: RBI reports

Priority sector lending (40% of total lending) has always been identified as the major reason of increase
in NPA in Indian banking system. This can be attributed to the direct lending system. The NPAs of the
priority sector have increased year on year. More than 55% of the scheduled commercial banks NPAs
are from priority sector. The public sector had been more adversely affected by this as compared to the
private sector. The government in pursuit of populist measures and benefit to small farmers and
enterprises encourages public banks to lend directly (Government is the majority stakeholder in public
sector banks).On the other hand the private sector even in private sector has been conservative in
lending and has lent indirectly to priority sector through institutions like NABARD where risk of
default is less.
EFFECT OF PRIORITY SECTOR LENDING-DATA ANALYSIS

Table-3: Sector wise NPA(Priority sector) and Loan Advances for public sector and private banks

Page 7

Priority Sector NPA in Indian Banks

Year

Public
NPA in
Private
NPA in
Private
Public
Lending
sector Priority sector
Per cent of sector Priority sector sector
sector
Per cent of
Lending to
by Public
ANBC/OBE Lending to by Private
Total
Total NPA
ANBC/OBE
priority sector banks
priority
sector banks
NPA

2012
2011
2010
2009
2008
2007
2006
2005
2004

1130700.00
1028615.00
864564.00
724150.00
610450.00
521376.00
409748.00
310093.00
244456.00

562
413
308
243
252
229
223
234
238

1125
711
573
440
397
386
413
476
501

37.20
41.3
41.6
42.7
44.7
39.7
40.3
42.8
43.6

286400.00
248828.00
214669.00
187849.00
164068.00
144549.00
106586.00
69886.00
48920.00

51
48.23
47.92
36.41
34.18
28.8
22.8
21.8
26

183
180
173
168
130
92
78
87
104

39.40
46.6
45.9
46.2
42.5
42.9
42.8
43.6
47.3

The NPAs in priority sector were more in public sector banks when compared to private and foreign
banks.
To check the dependence of priority sector lending on banks NPA we hypothesized the Total NPA
value as dependent on the total lending to priority sector and NPA created within the priority sector.
We are comparing between the performance of public sector banks and private sector banks. Here the
regression equation is
NPA public = A0 +A1*Y1+A2*Y2
NPA private = B0+B1*Z1+B2*Z2
Y1=public sector lending to priority sector, Y2=NPA created within priority sector by public sector
banks
Z1=private sector lending to priority sector, Z2= NPA created within priority sector by private sector
banks.

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RESULTS AND INTERPRETATION

Table 4: Analysis result For Public sector banks:

SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations

0.989799
0.979701
0.972935
38.82445
9

ANOVA
df
Regression
Residual
Total

Intercept
Public sector Lending to priority
NPA in Priority sector by Public sector
banks

SS
MS
F
Significance F
2
436506
218253 144.7937
8.36366E-06
6 9044.027 1507.338
8
445550

Coefficients
Standard Error t Stat
P-value
Lower 95% Upper 95%Lower 95.0%
Upper 95.0%
-51.681 38.16752 -1.35406 0.224492 -145.0735291 41.71157 -145.074 41.71157
-0.00021 8.2E-05 -2.61951 0.039612 -0.000415352 -1.4E-05 -0.00042 -1.4E-05
2.495251 0.222432 11.21802

3E-05

1.950978227 3.039523 1.950978 3.039523

Regression analysis for public sector banks shows that the regression equation explains
97.3%(Adjusted R2) of total NPAs in public sector banks by the total lending to priority sector and
NPAs created in priority sector. Hence we can conclude that effect of priority sector lending on public
sector banks NPA is statistically significant (with F value 144.8).
Private sector Banks:
Table 5: Analysis result For Private sector Banks:

SUMMARY OUTPUT
Regression Statistics
Multiple R
R Square
Adjusted R Square
Standard Error
Observations

0.951121
0.904632
0.872842
15.54632
9

ANOVA
df
Regression
Residual
Total

SS
MS
F
Significance F
2 13755.43 6877.713 28.45698 0.000867387
6 1450.129 241.6881
8 15205.56

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Intercept
Private sector Lending to priority
NPA in Priority sector by Private sector banks

Coefficients
Standard Error t Stat
0.853539 22.57832 0.037803
-5.9E-05 0.000204 -0.28827
4.016128 1.424778 2.818775

P-value Lower 95% Upper 95%Lower 95.0%

Upper 95.0%
0.971071 -54.39362539 56.1007 -54.3936 56.1007
0.782837 -0.000556728 0.000439 -0.00056 0.000439
0.030403 0.529822478 7.502434 0.529822 7.502434

Regression analysis for private sector banks shows that the adjusted R2 value of 87% with much lower
F value (28.45). Hence we can conclude that the effect of priority sector lending on private banks NPA
is not statistically significant.
At the same time it is evident from the table, the percentage of Loan to priority sector (ANBC/OBE) is
comparable (due to RBI guidelines) and thus we can conclude that NPAs in public sector banks are
more sensitive towards priority sector lending than NPAs in private banks are.
MANAGEMENT OF NPAS

PREVENTIVE MEASURES:

The credit appraisal skills need to be changed as a lot of bad loans are being given due to this
reason. Economic viability, technical feasibility, quality of management and financial position
of the borrower should be evaluated properly.
Pre credit and post credit appraisals
Close monitoring of borrower accounts, site visits, factory visits should be done
Consultancy and technical services must be provided to the borrower units wherever necessary.

CORRECTIVE MEASURES

The corrective measures are taken when the loan has become an NPA. In this case a legal recourse is
taken. If we see the NPA performance over the years earlier NPAs were higher.(Exhibit1,2) The
performance over the years have increased due to setting up of systems which have ensured more
effective recovery of bank credit, putting a legal framework in place to give more teeth to creditors
when it comes to recoveries .The institutions and the mechanisms set up were the following
1. One time settlement / compromise scheme
2. Lok-adalat
3. Debt Recovery Tribunal

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4. Securitization and reconstruction of financial assets and enforcement of Security Interest Act 2002.
(SARFAISI Act)
5. Corporate Reconstruction Companies
6. Credit information on defaulters and role of credit information bureaus
HOW NPAS IMPACT A FINANCIAL INSTITUTION?

Moral hazard: Interest income cant be recognized on advances identified as NPA affecting profit,
along with that, further losses is created by provisioning. For this, lenders might tend to roll over any
potential Non performing loan expecting (even though might not be possible) future repayments, hence
creating ever greening. Such ever greening and non-viability of the concerned project simply
postpone the present problem and escalate it in future.
Adverse incentive: The higher percentage of NPA on balance sheet would press the lender to take risk
and exploit rest of the assets more aggressively to stay profitable as rest of the asset portfolio has to
cover the whole liabilities and earn enough amounts of profits for the quarterly targets. These risky
ventures automatically become potential NPAs for the future and a self-fulfilling cycle is created.
Opportunity cost and cost of capital for clients:
NPAs are basically lost opportunity, the money locked in as NPA could have used to increase the return
on assets for banks which could have been favourable for other potential borrowers as in that situation
they could avail lower interest rate and lower cost of capital. Also increasing number of NPAs
decrease credit rating of the bank, and investors loss confidence in Banks future and banks cost of
borrowing increases. (saha)
Difficult to maintain CAR as NPAs and hence RWAs increase
As in most of the cases, the government is a principal shareholder for the public sector banks it can put
pressure on the government expenditure as with high NPA amounting on banks balance sheet; it might
frequently need to bail out banks if proper structure is not in place.

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STEPS TAKEN TO HANDLE NPA PROBLEMS IN INDIA THROUGH ARCS:

Structural reforms in Indian credit market to recover NPAs-First was the securitization,
reconstruction of financial asset and enforcement of securities ordinance and subsequent
act(SARFAIESI Act) by president of India in 2002 by which lenders got the power to take management
control, sell assets to recover the debt, recover any receivable from the borrower, but within some legal
restrictions (like 75% of the lenders are required to agree upon the recovery process).The ordinance
also created options for the legal framework for the Asset reconstruction company(ARCs) with power
of enforcement of securities acquired by ARCs from the original lenders. ARCs were encouraged,
under some legal framework, for an open, efficient and fair auction of the assets to recover the best
possible value from the NPAs. Along with that Lenders and ARCs got the special power (with
restrictions) over the borrower regarding any appeal against the seizure of assets before court or DRT
(debt recovery tribunal).The ordinance and subsequent Act has made provisions and guidelines for
regulations and registrations of ARCs by RBI. It allows ARCs to raise funds through security receipts
to QIBs, though they cant raise funds from the public. The regulations and guidelines deal with the
minimum capital requirement, controlling interest of the sponsors (no single sponsor with 10% of the
equity capital), cap of foreign equity capital (49%), structure of board of directors (50% independent
directors).
IMPLEMENTATION ISSUES IN NPA RECOVERY:

1. Management control: Given the fact that banks will be incapable in handling the operations of
clients business, taking over the management control would require industry doctors, specialized
services which might not be easily available.
2. Quality and saleability of the securities: the quality of the securities may ultimately fetch
ridiculously low price in the auctions or lack or buyers at expected value as the assets might lose all
practical value (usability) or sometimes promoters can influence the buyers. Along with that market
price for the asset may come down. For example, when mortgage clients defaulted on payment in UK
in 1990s, building societies faced oversupply of real estate keeping the prices down at ridiculously low
level and they preferred restructuring of those loans.
3. Moral Hazard: In India, when the NPA story is more of a flow problem (substantial accretion) than
stock problem (one time cleansing of balance sheet) revolving around inappropriate evaluation and
monitoring process, if the ARCs are expected to handle bad loans created due to bad judgment or
collusion during evaluation of loan process, there is potential moral hazard created. If banks know they
can pass the bad loans off their balance sheet to the ARCs, they might be less cautious during the loan
appraisal process and recovery.
4. Price discovery of NPAs: When bad loans are transferred from banks to ARCs, they can either be
on book value or market value. Book value sales would be favourable for original lenders (as they
could recover the whole historical value) but that will simply translate the loss from one entity (banks)
to others (ARCs) hence creating unnecessary burdens on the ARCs. Hence market value sales seem
logical but that would require the actual price discovery of the asset which would be possible only if

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strong efficient secondary market is present. In absence of any strong secondary market, sale of such
asset at so called market value might create problems for public sector banks as it might be questioned
by central audit and the central vigilance commission in future as there might be some collusion or
conflicts of interests for the involved parties. This possibility would make the public sector banks
reluctant to the process (sale of the NPAs.)
5. Problems for capital adequacy: If the sale of NPAs happens at market value, the ARCs would buy
the asset at huge discounted price. For example, Danharta bought the assets with average discount of
48-50%.Such high discount would lead to capital erosion resulting in capital adequacy problems for the
banks which would require some safeguard. (Neeraj) (saha)
ISSUES FACED BY ARCS

Size and number of NPAs:

Almost half of NPAs with PSUs in India are within priority sector where per borrower NPA is small
whereas the total number of borrowers (volume) is huge, which can be evident from Exhibit4 with the
number of cases files in Lok adalats. These borrowers are present over a large geographical area and
are mainly concentrated in rural areas. Hence Banks with good branch network in rural areas are better
positioned to handle such loans as ARCs would be centralized in nature. Only large loans (approx. 50%
of the problem loans) above a certain threshold limit should be passed on to ARCs for proper
functioning of them. Among these loans, real estate constitutes small percentage. So the advantages for
ARCs in countries likes Sweden and USA wont be possible here.
Debt aggregation and consortium system:
For meaningful resolution of inter-creditor issues, it is necessary to have debt aggregation which wont
be always possible. Along with that the consortium based lending in India does not distinguish clearly
the first and second mortgages or the seniority of debts; hence it becomes difficult to structure the intercreditor agreements.
Underdeveloped NPA market with Funding problems and lack of Government backing:
We have an underdeveloped secondary market of NPAs, lack of domestic investors, and absence of
Government guarantee for the assets transferred to ARCs. Hence ARCs have to look for foreign capital
where obviously foreign investors will invest for relatively higher returns. Along with that there is a
cap on foreign institutional investors investment. As a form of investment in the ACT an SR is allowed
but FIIs are not eligible for that benefit. The global counterparts in China have no cap for FIIs in the
ownership of ARCs and along with that there is a tax incentive to encourage foreign participation.
Similar is the case in Korea where international bidding is allowed during the auctions.
CRITICAL ANALYSIS OF ARCS IN INDIA IN COMPARISON TO GLOBAL MODELS:

Around the globe generally three models are used to handle NPLs, i.e., Bank based models, Market
based model and government supported model. In bank based model, the loan remains with the bank
but placed to a subsidiary or a specialized unit. This has problems in terms of slow resolution,

Page 13

requirement of special skill sets in work out teams and above all risk-return trade off remains within the
bank. Market based model comes into picture when substantial economic crisis is absent though the
size of NPAs hinders efficiency of the banks. Here specialized intermediation by ARCs is done and
value of the assets is recognized through market forces. Government supported models come into
picture in economic crisis and intended for a one time clean up while the government bears the cost of
such clean up by creating a central ARC. These nodal ARCs raise money from third party investors and
thus the risk and reward trade-off is transferred. South eastern Asian countries followed these models
during crisis as part of their knee-jerk reactions. Indonesia (IBRA), Thailand (TAMC), Malaysia
(Danhartha), and Korea (KAMCO) have followed the government supported approach whereas
Philippines, China have encouraged private entities through fiscal incentives and laws to unload bad
loans. India has a mix of market and bank based model.
One Time solution with Sunset clause: If we compare Indian ARCs with their global counterparts, the
difference becomes evident in the crisis they are supposed to handle. ARCs are expected to deal with
the systemic crisis which creates the bad loans in the banking system. So the global counterparts acted
as a one-time remedy with a sunset clause. For example, Resolution Trust Corporation of USA in 1990s
which dealt with the problem of loans association, during south Asian crisis in late 90s, Danharta in
Malaysia dealt with the bad loans created due to systemic crisis. But In India, ARCs are formed as
some business model, as considered in the SARFAESI act, and in absence of any sunset clause, they
are unlikely to be a remedy for any systemic crisis functioning as a normal business model, and they
would be more concerned about future growth rather than a one-time solution.
PERFORMANCE OF INDIAN ARCS AND OTHER RECOVERY CHANNELS:

ARCs in India are given special powers (though regulated) and the objective of Maximization of
shareholders wealth (ARC shareholders) by taking up and resolving bad loans through these special
power seems paradoxical as these loans occur due to lack of due diligence in the process. Along with
that, if power can corrupt, so can a special power. Though the assets sale of bad loans are not supposed
to have a borrower centric consideration but assets can be sold at not so fair price and in maximum of
the cases, borrowers are given only the minimum details which can raise transparency issue.
Along with that, Indian ARC model can buy NPAs in the name of a trust, in which ARC acts as a
trustee even though they can exercise the special power while acting as a trustee. This device can avoid
the RBI regulations regarding NPA treatment, capital adequacy, and income recognition whereas ARCs
on their own are subject to these regulations like NBFCs. when the assets are on the books of trusts
with relaxed regulation, the special privilege to the trustee(ARC) is not logical.
The main rationale for a market based model in India was that government officials involvement might
spark the public criticism and in future there might be auditory ramifications regarding the
determination of fair market value of the distressed assets. On the other hand, Private ARCs were
expected to find the lowest possible but appropriate price from the banks. With only profit driven
motive of private ARCs, obviously the more promising NPAs become the target of private ARCs
which is contrary to Governments vision of ARCs as nursing home for distressed companies and a
long term solution for the problems.

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Success of the recovery channels:

From Exhibit4, it is evident that Among all the recovery channels, through SARFAISE act majority of
NPA is recovered (as a percentage of total recovered) with a sudden spike after 2010.It shows
SARFAISI act is our best available channel but there is a downward trend in the SARFAESI channel yo-y basis comparing with the amount involved creating some concerns on its efficiency.
Proposed Change in SARFAISI act and its implications: in December 2012, Parliament approved
the bill the amend SARFAESI act giving ARCs and banks the right to convert any part of the Debt into
equity and a chance for the lenders to become an equity partner of the defaulting companies. The
underlying logic is that lenders can gain from any appreciation of the share prices in future. The
downside risk of such step is that share price of such stocks might fall further than the exercise price
and hence increasing the loss for the lenders. This amendment also allows banks to bid for the
immovable property of the defaulters themselves (in absence of any other bidders) to be sold to a new
bidder at any later date (expecting appreciation in values), but they can carry the property for maximum
of seven years (as per Banking Regulation Act, 1949.) (Express, 2012)
NPA SYSTEMS IN ASIAN ECONOMIES

The Asian countries had the advantage of taking cue from the western world when it came to the
restructuring and bankruptcy systems in terms of what are more effective. The challenge is to address
the problems in nature of their own economy dependent on the country social, political and cultural
intricacies
JAPAN:

Reforms in Japan the NPL area started in 1997 (though the foreign investors were keen to invest in the
market from 1993 onwards). In 1997 the amount of bad loans with Japanese banks had increased to a
point where banks had to sell the loans or go bankrupt. At this point the foreign investors bought very
aggressively .In the year 1998-99 an estimated $600 billion paper was sold. Now local players have
also entered this market. Barriers to entry in this market are highmany auctions are invitation-only
and the company needs to have a sound relationship with Japanese financial network to get the
invitations.
Japans NPL market will grow both in the short term and in the long term. The Financial Services
Agency, which regulates and supervises all financial institutions especially regional banks, credit
unions and credit associations, is pushing for banks to improve their balance sheets. This may lead to
increased selling of NPLs as well as a strengthening of their collection systems.
CHINA:

Four AMCs were established in 1999 when their banking system underwent an overhaul. Banks could
sell their NPAs only to 4 AMC companies. The NPLs they acquired from the big four state-owned
banks in 1999 were transferred at their full face value of approximately US$171 billion in exchange for
10-year bonds. As the underlying value of the NPLs transferred was clearly significantly less than the
face amount of the loans acquired, it was never clear how the AMCs would have the funds to repay the

Page 15

notes upon maturity. However, When the big four banks began going public in 2005 the Ministry of
Finance in its notification made clear that would, if necessary, provide support with respect to the
AMCs repayment obligations.
Process:
The AMCs can sell the bad loans to the investors. They act as an intermediary only. But over these
years foreign in China investors have faced difficulties in acquiring control of assets from AMCs due
to predominantly two factors: a nearly impossible-to-overcome bid/ask spread (the AMCs focus on
their acquisition cost of the loans while investors focus on their recovery value) and an unpredictable
approval process. Some investors including Goldman Sachs have left China. Even investors who have
been able to acquire the assets are facing difficulties since there is no proper legal system or collection.
Since late 2007, courts across China have invoked a self-imposed three suspension policy the
suspension of filing of new NPLrelated cases, obtaining judgments on existing cases and execution of
decisions made pending due to the supreme court judgment. This has also turned negative for the
investors who cannot now approach the courts.
The Chinese system has always been reluctant in handing over the NPAs to the foreign investors
particularly when it comes to state owned enterprises. The supreme court guidance which came out in
2009 also dis-incentivized the state owned or state controlled enterprises by saying that if any
organization(which has NPAs) undergoing reorganization the court should not accept cases for it even
if it has been sold to the distributor. The Supreme Court guidance invalidated the NPA sale for number
of reasons like the debtor or Guarantor being a government body, auction formats not being properly
followed, necessary approvals not being obtained, and the all-inclusive any other situations involving
national or public interest. (PWC, 2012)
Graph-1:NPA Across all countries:

Source: World Bank data Indicator

Page 16

The graph shows the comparisons of NPA across all countries. India showed substantial improvement
after 2003 with the SARFAISI act and also due to higher GDP growth. Along with that, it shows steady
increase of NPLs in USA around the financial crisis of 2008.
FUTURE:

Even when the ARCs are envisaged totally in the private sector, it is necessary for them to have
complete operational independence. As Banks and financial institutions, through SRs, are their major
shareholders, arms-length transaction is necessary to avoid any window-dressing of the NPA problem.
With corporate bond market picking up in future with possible stable credit rating agencies, good
players will go directly to the bond market. That might cause the bad players concentration to go high
in loan market to banks resulting in potential increase in NPAs. Banks and FIs can mitigate the risk by
investing in those bonds.
CONCLUSION:

1. Recapitalization strategy if the banks recognize losses due to NPAs and end up having lower
capital levels, the recapitalization strategy from RBI will encourage banks not to roll over the
potential NPA to the future.
2. Foreign capital in ARCs: for capital requirement of private ARCs, more foreign capital
should be encouraged with some incentives (tax) like the ARCs in China.
3. Threshold level for ARCs: ARCs are not equipped to handle priority sector loans. Since these
loans which are given to small farmers are small loans which are large is number it is very
difficult for ARCs to follow up. It increases the workload of the ARC to handle numerous
small ARC loans. At the same time penetration is a major factor with large parts of rural India
still grappling with the problem of connectivity .In this regard a central bank which has access
to these remote locations is better equipped to handle the NPAs. Thus ARCs should be given
only loans above a particular size.
4. Securitization: Development of a security market in India for the loan products through which
actual price discoveries of loans and NPAs will be possible.
5. Bond Market and its impact: Though Corporate bond market is not developed in India, a
developed corporate bond market will change the scenario for financial institutions. With bond
market with proper rating agencies and regulations in place, large and creditworthy players
(with good credit ratings) will shun the loan market and will raise funds at much lower cost
(low coupon rate with higher ratings).Hence Banks will have to either accommodate either the
small players with questionable creditworthiness or Banks can invest in the corporate bond
market but the interest income will be less than the income possible from the loan market.
Though that might hamper the interest rate margin for banks (as they would be raising capital
through same deposit rate).To compensate for the reduced margin, Banks might have to carry
riskier loan portfolios in the loan market with potential increase in NPAs. At the same time,
proportion of NPAs from bonds of established players would decrease with a developed bond
market and price discovery in the secondary market, thus having a positive effect on banks

Page 17

NPA. To avoid the riskier loans in the loan market and to avoid the risk of NPAs, lowering of
savings deposit rate along with a developed bond market is necessary.
6. New Banking licenses: With new banking licenses being proposed targeting all inclusive
growth, specifically in rural India, maximum of the branches of the new banks may turn out to
be potential loss centres for the new banks, at least in short term, as the restrictions of number
branches will be imposed on the new banks. To meet the profit targets, these banks might end
up having riskier loans on their books in those rural areas given the fact that priority sector
lending has more impact in NPAs of banks. Hence, new banking licenses should be provided to
those companies who will have sound financial strength and sound credit appraisal process.

Page 18

REFERENCES
bank, w. (2013, August). world bank. Retrieved from data-world bank:
http://data.worldbank.org/indicator/FB.AST.NPER.ZS/countries/1W-IN-CN-US-BR?display=graph
BOYAZNY, M. (n.d.). Taming the Asian Tiger-Revival of Non-Performing Assets. Euromoney Institutional Investor.
Express, I. (2012, december). Retrieved from Indian express: http://www.indianexpress.com/news/parliament-approveschanges-in-sarfaesi-act/1043247/
Finnacle, I. (2012). NON performing assets-An Indian perspective.
Kalra, R. (2012). Non-Performing Assets-of Commercial Banks: A Case Study. The IUP Journal of Monetary Economics.
Kothari, V. (2011). Asset Reconstruction Companies.
Mahapatra, D. M. (2012). Impact of NPAs on profitablity of commercial banks. Aveshkar.
Neeraj, T. (n.d.). Resolution of NPA in India:. PRATTS JOURNAL OF BANKRUPTCY LAW.
Patidar, D. (n.d.). ANANALYSIS OF NPA IN PRIORITY SECTOR LENDING: A.
PWC. (2012). PWC newsletter. Retrieved from http://www.pwc.com/gx/en/non-performing-loan-news/index.jhtml
RBI. (2012, july). RBI master circulars. Retrieved from RBI:
http://www.rbi.org.in/scripts/BS_ViewMasCirculardetails.aspx?id=7370
RBI. (2012-13). RBI. Retrieved from RBI-Pririty Sector: http://rbi.org.in/scripts/FAQView.aspx?Id=87%20-priority
RBI. (2013, July). RBI notification. Retrieved from http://rbidocs.rbi.org.in/rdocs/notification/PDFs/62MCIRAC290613.pdf
saha, K. (n.d.). Can the ordinance recover NPAs. IIMB-Management Review.
times, e. (2011, july). New paper . Retrieved from economic times: http://articles.economictimes.indiatimes.com/2011-0718/news/29787351_1_arcil-bad-loans-idbi-bank
Veerakumar, K. (2012). Non-Performing Assets in Priority Sector: A Threat to Indian Scheduled Commercial Banks.
International Research Journal of Finance and Economics.

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EXHIBITS

Exhibit-1

Exhibit2

Page 20

Exhibit-3
GDP vs Loan Advances by Indian Banks
4000000
3500000

y = 227.86x - 1E+06
R = 0.9333

3000000
2500000
Loan Advances 2000000

Series1

1500000

Linear (Series1)

1000000
500000
0
0

5000

10000

15000

20000

India GDP(*10^8)

Exhibit-4
Recovery Channel
Lok Adalat

DRTs

SARFAESI ACT

Total

SARFAESI ACT/
TOTAL(recovered)

Particulars
2006-07 2007-08 2008-09 2009-10 2010-11 2011-12
No. of cases referred
160,368 186,535 5,48,308 7,78,833 6,16,018 4,76,073
Amount involved (a)
758
2,142
4,023
7,235
53
17
Amount recovered (b)
106
176
196
112
2
2
% (b) / (a)
13.98%
8.22%
4.87%
1.55%
3.77% 11.76%
No. of cases referred
4,028
3,728
2004
6,019
12,872
13,365
Amount involved (a)
9,156
5,819
4,130
9,797
141
241
Amount recovered (b)
3,463
3,020
3,348
3,133
39
41
% (b) / (a)
37.82% 51.90% 81.07% 31.98% 27.66% 17.01%
No. of cases referred
60,178
83,942
61,760
78,366 118,642 1,40,991
Amount involved (a')
9,058
7,263
12,067
14,249
30,600
35,300
Amount recovered (b)
3,749
4,429
3,982
4,269
11,600
10,100
% (b) / (a)
41.39% 60.98% 33.00% 29.96% 37.91% 28.61%
Amount involved (c)
18,972
15,224
20,220
31,281
30,794
35,558
Amount recovered (d)
7,318
7,625
7,526
7,514
11,641
10,143
% (b) / (a)
38.57% 50.09% 37.22% 24.02% 37.80% 28.53%
% a'/d

51.23%

58.09%

52.91%

56.81%

99.65%

99.58%

Source: compiled from banking trend reports, RBI

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