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BankingSysteminIndiaNonPerformingAssets

NonperformingAssets(NPAs)

INTRODUCTION

InthelastarticleonUnderstandingthebankingsystem,wehaddiscussedtheBaselnorms.

WelearntwhatBaselnormsareandwhytheyholdsuchimportancefortheIndianbankingsystem.Thenweunderstoodthechallengesthebankswillhavetofaceinimplementingthem.Further,wesuggestedapossiblewayout.

Previousdiscussionhighlightedwhystabilityinthebankingsystemisimportant.Followingthatdiscussion,inthisarticlewewillbediscussingoneofthebiggestchallengesthreateningthestabilityoftheIndianbankingsystemtheNonPerformingassets(NPAs).

ThebankingbusinesshasboomedsinceIndependence,particularlyaftertheLPGreforms.ThesectoriscurrentlyvaluedatRs115lakhcroreandexpectedtomorethandoubleatRs288lakhcroreby2020.Outofthis70percentofbusinessisbeingdonebyPSUbanks.AninterestingfactisthatSBIsmarketshareoutoftotalbankingbusinessis22percent!

Lookingattheenormoussizeofthebankingindustry,theNPAsareabigcauseofconcern.

WewillfirstlookatsomeofthebasicsofNPAsthenmoveontounderstandtheircausesandimplicationsthenexaminethechallengesthatthebankswillfacebecauseofthemandfinallyputforwardpossiblesolutions.

ThediscussionwillalsocoverthesocialagendabehindthebankingandwhetheritisunviablefortheIndianbanks.

WHATARENPAS?

Generallyspeaking,NPAisanyassetofabankwhichisnotproducinganyincome.

Inotherwords,aloanorleasethatisnotmeetingitsstatedprincipalandinterestpayments.



Onabanksbalancesheet,loansmadetocustomersarelistedasassets.Thebiggestrisktoabankiswhencustomerswhotakeoutloansstopmakingtheirpayments,causingthevalueoftheloanassetstodecline.

Criteria

Loansdontgobadrightaway.Mostloansallowcustomersacertaingraceperiod.Thentheyaremarkedoverdue.Afteracertainnumberofdays,theloanisclassifiedasanonperformingloan.

Banksusuallyclassifyasnonperformingassetsanycommercialloanswhicharemorethan90daysoverdueandanyconsumerloanswhicharemorethan180daysoverdue.

Foragriculturalloans,iftheinterestand/ortheinstallmentorprincipalremainsoverduefortwoharvestseasonsitisdeclaredasNPAs.But,thisperiodshouldnotexceedtwoyears.Aftertwoyearsanyunpaidloan/installmentwillbeclassifiedasNPA.

Categories

1.Substandard:WhentheNPAshaveaged12months.

3.Lossassets:Whenthebankoritsauditorshaveidentifiedtheloss,butithasnotbeenwrittenoff.

Afteracertainamountoftime,abankwilltrytorecoupitsmoneybyforeclosingonthepropertythatsecurestheloan.ThewaymoneyisrecoupedisahighlycontentiousissuenotjustwithbanksbutalsowithMicroFinanceInstitutions(MFIs).Wewilldiscussitlaterinthearticle.

Allofthiscanbeexplainedinamuchmoretechnicalmanner,butthatisnotrequiredhere.Forexample,wedonotneedtolistalltheconditionsthatmakethebanksdeclareanassetasNPAslikeInrespectofderivativetransactions,theoverduereceivablesrepresentingpositivemarktomarketvalueofaderivativecontract,iftheseremainunpaidforaperiodof90daysfromthespecifiedduedateforpayment.

Onlyunderstandingthebasicconceptswillsuffice.UPSCisnotgoingtoaskyouthesedetails,butabouttheimpactandsolutionsofNPAs.Eveninprelims,thesedetailswillnotbeasked.Soweavoidtechnicalitiesandjargonshere.ItisnotusefulforaGSpaper,evenifsomeofitmaybeusefulforEconomicsoptionalpaper.

EXTENTOFNPAs

GrossNPAsofdomesticbanksjumpedto4.2%oftotallendingbytheendofSeptember2013from3.6%sixmonthsbefore,accordingtotheReserveBankofIndia(RBI).



AsperarecentwarningbytheRBI,badloans(NPAs)couldclimbto7%oftotaladvancesby2015.

Inabsoluteterms,grossNPAsareestimatedtotouchRs2.50lakhcroresbytheendofMarchthisyear.ThisisequaltothesizeofthebudgetofUttarPradesh.Thebiggestchunkofthesoureddebtsiswithstaterunbanks(PublicsectorbanksorPSBs),whichaccountfortwothirdsofloansbut80%ofthebadassets.

ThisishowtheNPAcurvehasbeenmovingintherecentyears,asperanewsreportintheBusinessStandard:

Privatesectorandforeignlendersarebetterplaced.TheirNPAsinproportionoftheirlendingislesserthanthatofthePSBs.

WHYITMATTERS?

Thehigheristheamountofnonperformingassets(NPAs),theweakerwillbethebanksrevenuestream.

Intheshortterm,manybankshavetheabilitytohandleanincreaseinnonperformingassetstheymighthavestrongreservesorothercapitalthatcanbeusedtooffsetthelosses.Butafterawhile,ifthatcapitalisusedup,nonperformingloanswillimperilabankshealth.Thinkofnonperformingassetsasdeadweightonthebalancesheet.

HereistheimpactoftheNPAs:

AstheNPAofthebankswillrise,itwillbringascarcityoffundsintheIndiansecuritymarkets.Fewbankswillbewillingtolendiftheyarenotsureoftherecoveryoftheirmoney.

Theshareholdersofthebankswilllosealotofmoneyasbanksthemselveswillfindittoughtosurvivein



themarket.

Thiswillleadtoacrisisofconfidenceinthemarket.Thepriceofloans,i.e.theinterestrateswillshootupbadly.Shootingofinterestrateswilldirectlyimpacttheinvestorswhowishtotakeloansforsettingupinfrastructural,industrialprojectsetc.

Itwillalsoimpacttheretailconsumerslikeus,whowillhavetoshelloutahigherinterestrateforaloan.

Allofthiswillleadtoasituationoflowofftakeoffundsfromthesecuritymarket.ThiswillhurttheoveralldemandintheIndianeconomy.And,finallyitwillleadtolowergrowthratesandofcoursehigherinflationbecauseofthehighercostofcapital.

Thistrendmaycontinueinaviciouscircleanddeepenthecrisis.

TotalNPAshavetouchedfiguresclosetothesizeofUPbudget.ImagineifalltheNPAwasrecovered,howwellitcanaugurfortheIndianeconomy.

RBIgovernorRaghuramRajanhasrecentlysaidthatNPAsmustbecurbedbeforetheproblembecomesalarming.

WHYSUCHASITUATION?

TherisingincidenceofNPAshasbeengenerallyattributedtothedomesticeconomicslowdown.Itisbelievedthatwitheconomicgrowthslowingdownandrateofinterestgoingupsharply,corporateshavebeenfindingitdifficulttorepayloans,andithasaddeduptorisingNPAs.EvenfinanceministerPChidambaramstatedthatbadloansareafunctionoftheeconomyandhence,havingbadloansduringdistressedtimesisverynatural.

However,TheNPAmessisnotentirelybecauseofthereversalofeconomiccycles.

Herewelookattheotherreasonsbehindthismess.BasicallythewholeproblemcanbedividedintotwopartsExternalproblemsandinternalproblemsasfacedbythebanks.

ExternalFactors

Reasonsrelatedtothecorporatesector

1. ApartfromtheslowdowninIndia,theglobaleconomyhasalsosloweddown.

ThishasadverselyimpactedthecorporatesectorinIndia.Continuinguncertaintyintheglobalmarketshasleadtolowerexportsofvariousproductsliketextiles,engineeringgoods,leather,gemsetc.Itcanbenotedthatimportsandexportscombinedequaltoaround40%ofIndiasGDP!

Ahurtcorporatesectorisfindingitdifficulttopayloans

2. Thebaninminingprojects,delayinenvironmentalrelatedpermitsaffectingpower,ironandsteelsector,volatilityinpricesofrawmaterialandtheshortageinavailabilityofpowerhaveallimpactedtheperformanceofthecorporatesector.Thishasaffectedtheirabilitytopaybackloans.



Othersectors

BanksinIndiaarehighlyregulated.Prioritysectorlending(PSL)isoneoftheseregulationswhichrequirethebankstogiveacertain%oftheirloanstocertainsectionsofsociety.Thesearefarmers,SCs,STs,ITparks,MSMEsetc.

NaturallyonewouldassumethattheweakersectionscoveredunderPSLaretheonestobeblamedforthesituation.However,itisnotthecase.

Asperrecentnewsreports,theStandingCommitteeonFinancewillbenowexaminingthereasonsforhighNPASinPSBs.

Thedata,sharedwiththeStandingCommittee,showsthatNPAsinthecorporatesectorarefarhigherthanthoseinthepriorityoragriculturesector.

Withintheprioritysector,incrementalNPAsweremoreinrespecttomicrosmallandmediumenterprisesfollowedbyagriculture.

However,eventhePSLsectorhascontributedsubstantiallytotheNPAs.

AsperthelatestestimatesbytheSBI,educationloansconstitute20%ofitsNPAs!

Thesluggishlegalsystem(JudiciaryinIndia)andlackofsystematicandconstanteffortsbythebanksmakeitdifficulttorecovertheseloansfrombothcorporateandnoncorporate.

InternalFactors

1.Indiscriminatelendingbysomestateownedbanksduringthehighgrowthperiod(200408)isoneofthemainreasonsforthedeteriorationinassetquality.

2.Bankerssaythereisalackofrigourinloanappraisalsystemsandmonitoringofwarningsignalsatstaterunbanks.Thisisparticularlytrueincaseofinfrastructureprojects,manyofwhicharestrugglingtorepayloans.Besides,theseprojectsgoonfor20to30years.

3.Poorrecoveryanduseofcoercivetechniquesbybanksinrecoveringloans

4.ThewaitandwatchapproachofbankshavebeenoftenblamedasthereasonforrisingNPAsasbanksallowdeterioratingassetclasstogofrombadtoworseinthehopeofrevivalandoftenofferrestructuringoptionto



corporates.

AParliamentarypanel,examiningincreasingincidentsofNPAs,hasobservedthatstateownedbanksshouldstopevergreeningorrepeatedrestructuringofcorporatedebttochecktheconstantbulgingoftheirnonperformingassets.MembersofthepanelwereoftheviewthatNPAsaretheresultofbadeconomicsituation,buttherewerealsomanagementissueofeverygreeningofloans,whichcouldbeavoidedbynotrenewingloans,particularlyofcorporate.

Therefore,itcanbeclearlyseenthatitisonlytheeconomicslowdownthatisbehindtheNPAs.Thereareawholerangeoffactors.

WAYOUT

ThesimplestapproachtocutdownNPAsistorecoverthebadloans.

ApartfromtheregularguidelinesreleasedbytheRBI,tostrengthenfurthertherecoveryofduesbybanksandfinancialinstitutions,GovernmentofIndiapromulgated:

1.TheRecoveryofDebtsDuetoBanksandFinancialInstitutionsAct,1993

2.TheSecuritizationReconstructionofFinancialAssetsandEnforcementofSecurityInterest(SARFAESI)Act,2002.

So,howcanthebankslegallyrecovertheirloans?

(i)TheSecuritizationandReconstructionofFinancialAssetsandEnforcementofSecurityInterest(SARFAESI)Act,2002TheActempowersBanks/FinancialInstitutionstorecovertheirnonperformingassetswithouttheinterventionoftheCourt,throughacquiringanddisposingofthesecuredassetsinNPAaccountswithoutstandingamountofRs.1lakhandabove.Thebankshavetofirstissueanotice.Then,ontheborrowersfailuretorepay,theycan:

Takepossessionofsecurityand/or

Takeoverthemanagementoftheborrowingconcern.

Appointapersontomanagetheconcern.

(ii)RecoveryofDebtsDuetoBanksandFinancialInstitutions(DRT)Act:TheActprovidessettingupofDebtRecoveryTribunals(DRTs)andDebtRecoveryAppellateTribunals(DRATs)forexpeditiousandexclusivedisposalofsuitsfiledbybanks/FIsforrecoveryoftheirduesinNPAaccountswithoutstandingamountofRs.10lacandabove.Governmenthas,sofar,setup33DRTsand5DRATsalloverthecountry.

(iii)LokAdalats:Section89oftheCivilProcedureCodeprovidesresolutionofdisputesthroughADRmethods



suchasArbitration,Conciliation,LokAdalatsandMediation.LokAdalatmechanismoffersexpeditious,inexpensiveandmutuallyacceptablewayofsettlementofdisputes.

GovernmenthasadvisedthepublicsectorbankstoutilizethismechanismtoitsfullestpotentialforrecoveryinNonperformingAssets(NPAs)cases.

Amongthevariouschannelsofrecoveryavailabletobanksfordealingwithbadloans,theSARFAESIActandtheDebtRecoveryTribunals(DRTs)havebeenthemosteffectiveintermsofamountrecovered.

TherecentcontroversysurroundingloanrecoveryinIndiaViewsoftheSC

Bankshavebeenallegedtoengageincoercivepracticestorecovertheloans.Recently,therehavebeensomejudicialpronouncementsbytheapexcourtdeterminingthescopeofpowersofenforcementofsecuritieswithouttheinterventionofthecourts,bythebanksandFIsundertheSARFAESIAct.Theapexcourthasreiteratedtheneedtoprotecttheinterestofborrowers,andemphasizedthattheexerciseofextraordinarypowersofrecovery,bybanksandFIsmustbeincompliancewiththeprovisionsoftheSARFAESIAct.

AspertheSupremeCourt(SC)Liquidityoffinancesandflowofmoneyisessentialforanyhealthyandgrowthorientedeconomy.Butcertainly,whatmustbekeptinmindisthatthelawshouldnotbeinderogationoftherightswhichareguaranteedtothepeopleundertheConstitution.Theprocedureshouldalsobefair,reasonableandvalid,thoughitmayvarylookingtothedifferentsituationsneededtobetackledandobjectsoughttobeachieved.

But,thesearestepswhichcurethediseaseofNPAs.TheissueofNPAsneedstobetackledatthelevelofpreventionratherthancure.

Therefore,thestepsthatcanpreventthepilingupofNPAsareasfollows:

1.Conservatism:

BanksneedtobemoreconservativeingrantingloanstosectorsthathavetraditionallyfoundtobecontributorsinNPAs.Infrastructuresectorisonesuchexample.NPAsrisepredominantlybecauseoflonggestationperiodoftheprojects.Therefore,theinfrastructuresector,insteadofgettingloansfromthebankscanbefundedfromInfrastructureDebtFunds(IDFs)orotherspecializedfundsforinfrastructuraldevelopmentinthecountry.

2.Improvingprocesses:



Thecreditsanctioningprocessofbanksneedstogomuchmorebeyondthetraditionalanalysisoffinancialstatementsandanalyzingthehistoryofpromoters.Forexample,banksrelymoreontheinformationgivenbycreditbureaus.However,itisoftennoticedthatseveraldefaultsbysomecorporatearenotregisteredintheircredithistory.

3.Relyinglessonrestructuringtheloans:

Insteadofsittingandwaitingforaloantoturntoabadloan,andthenrestructureit,thebanksmayofficiallystarttoworktorecoversuchaloan.Thiswillobviatetheneedtorestructurealoanandseveralissuesassociatedwithit.Oneestimatesaysthatby2013therewillbeRs2trillionworthofrestructuredloans.

4.ExpandinganddiversifyingconsumerbasebyInnovativebusinessmodels:

Contrarytopopularperceptions,theNPAinnoncorporatesectorislessthanthatinthecorporatesector.Hence,thereisaneedtoreachouttopeopleinremoteareaslackingconnectivityandaccessibility.Moreandmorepoorpeopleinruralpocketsshouldbebroughtunderthebankingsystembyadoptingnewtechnologiesandelectronicmeans.Innovativebusinessmodelswillplayacrucialrolehere.Otherwise,theNPAsmayincreaseinsteadofdecreasing.

AssaidbythenewM.D.ofSBI,Mr.Viswanathanproposedideassuchasasingledemataccountforallinvestmentsandcreditcardsforschoolstudents(aboveclass8th)tomakethemawarewiththebankingsystem.

CONCLUSION

Lookingatthegiantsizeofthebankingindustry,therecanbehardlyanydoubtthatthemenaceofNPAsneedstobecurbed.ItposesabigthreattothemacroeconomicstabilityoftheIndianeconomy.AnanalysisofthepresentsituationbringsustothepointthattheproblemismultifacetedandhasrootsineconomicslowdowndeterioratingbusinessclimateinIndiashortagesinthelegalsystemandtheoperationalshortcomingofthebanks.Therefore,ithastobedealtatmultiplelevels.Thegovernmentcantbeexpectedtorescuethestaterunbankswithtaxpayersmoneyeverytimetheyfallintoacrisis.But,thekindofattentionwithwhichthisproblemhasbeenreceivedbypolicymakersandbankersalikeisabigrayofhope.Rightsteps,timelyandconcertedactionsandarevivaloftheIndianeconomywillputalidonNPAs.Prevention,however,hastobecomeaprioritythanmerecure.

MODELQUESTIONS



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1. Answered

2. Review

1. Question1of5

1.Question

Considerthefollowingstatements:

1. InIndia,theprivatesectorbankshavealargermarketsharethanthepublicsectorbanks.

2. TheNPAsoftheprivatesectorbanksarefargreaterthanthatofthepublicsectorbanks.

Choosethecorrectanswerusingthecodesbelow:

Correct

Solution:d)

Incorrect

Solution:d)

2. Question2of5

2.Question

WhichofthefollowingfactorsMAYadverselyaffectthelevelofNPAsoftheIndianbanks?

1. Sloweconomicgrowth.

2. Substantialdelayinbankfundedinfrastructuralprojects.

3. PrivatizationofthePSBs.




Correct

Solution:a)

Incorrect

Solution:a)

3. Question3of5

3.Question

Considerthefollowingstatements:

Assertion(A):TheNPAsunderthecorporatesectoraremuchlesserthantheonesgivenunderPrioritySectorlendingnorms.

Reason(R):ThePSLnorms,interalia,covertheweakersectionsofthesocietywhomaybeunabletopayloansontime.

Inthecontextofthestatementsabove,whichoftheseistrue?

Correct

Solution:c)

Incorrect

Solution:c)

4. Question4of5

4.Question

DisputesconcerningNPAsinIndia,canbesortedoutbywhichofthesemechanisms:

1. Arbitration

2. MovingtheLokAdalat

3. Movingtheconcernedquasijudicialandregulatoryauthoritiesincaseofinfrastructureprojects.


Correct

Solution:a)

Incorrect

Solution:a)



5. Question5of5

5.Question

WhichofthefollowingcanbepossibleconsequencesofveryhighunmanageableNPAs?

1. Economicslowdownandpossiblerecession.

2. Riseininterestratesofloans.

3. Scarcityoffundsinthesecuritymarket.


Correct

Solution:d)

Incorrect

Solution:d)

Mains

1.Inyourview,whatcanbethepossiblereasonsbehindtheincreasinglyhighNPAsoftheIndianbanks?HowfarcanthisbeattributedtotheconditionsprevailingintheIndianandglobaleconomy?(300words)

2.ExplainhowhighNPAscanbedamagingtotheIndianeconomy.(200words)

3.HowfarcanfinancialinclusionhelpincontainingthehighlevelofNPAsofbanksinIndia?Substantiateyourviewswithtwoexamples.(200words)

4.WhatarethelegalmechanismsthatcanbeusedtocontaintheNPAs?BringoutclearlytheroleofeachactortheRBI,theGovernmentofIndia,andthebanksinachievinglowerNPAsthroughlegalmechanisms.(300words)

5.TheInfrastructuralprojectsarefacedwithseveralproblemsespeciallyrelatedtofinancingoftheprojectsbycommercialbanks.Examinethebottlenecksinthepresentsystemoffinancing.Whatcanbedonetoaddresstheseissues?(200words)

6.DespitehavingamuchlargershareintheBankingmarket,thestateownedbankshavenotperformedwellfinancially.Criticallyexamine.Cantheproblemberesolvedbydenationalizingthepoorlyperformingbanks?(300words)

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