npa the unbridled virus and an emerging challenge to

8/6/2019 NPA the Unbridled Virus and an Emerging Challenge To

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Table of Contents - The Emergence of NPA in Indian Banking & Financial

Institutions and its Dimensions - List of Articles Covered

i. NPA the Unbridled Virus and an Emerging Challenge to Indian Banking System - The

Emergence of NPA in Indian Banking & Financial Institutions and its Dimensions ii. Adverse Effects of NPA on the Working of Commercial Banks iii. The Unseen and Unperceived Edge of NPAiv. Focus at Anomalies at the Credit Delivery Centre - A Detached Survey of NPA from

within the Credit Agencyv. Diagnosis of the Root Cause and Tracing the Solution -- Self-Introspection by

Industry, Business and Banksvi. In Retrospect - Efforts, Results & Reviewvii. Measures Initiated by RBI and Government of India for Reduction of NPAs

NPA the Unbridled Virus and an Emerging Challenge toIndian Banking System - The Emergence of NPA in Indian Banking &

Financial Institutions and its Dimensions

[The article gives the position of Indian Banking as seen in the year 2001]

Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to thebanking industry in our country sending distressin g signals on the sustainability andendurability of the affected banks. The positive results of the chain of measures effectedunder banking reforms by the Government of India and RBI in terms of the two NarasimhanCommittee Reports in this contemporary pe riod have been neutralised by the ill effects ofthis surging threat. Despite various correctional steps administered to solve and end thisproblem, concrete results are eluding. It is a sweeping and all pervasive virus confronted

universally on banking and financial institutions. The severity of the problem is howeveracutely suffered by Nationalised Banks, followed by the SBI group, and the all IndiaFinancial Institutions.

As at 31.03.2001 the aggregate gross NPA of all scheduled commercial banks amounte d toRs.63,883 Crore. Table No.I gives the figures of gross and net NPA for the last four years. Itshows an increase of Rs.13,068 Crore or more than 25% in the last financial year, indicatingthat fresh accretion to NPA is more than the recoveries that we re effected, thus signifying alosing battle in containing this menace.

Table No. INPA Statistics -All Scheduled

Commercial Banks

.................................. (Amountin Crores) Year

TotalAdvances

GrossNPA

NetAdvances

NetNPA

%-age ofGross

NPA to

totaladvances

%-age ofNet

NPA to

netadvances

1997-98 352697 50815 325522 25734 14.4 7.3

1998-99 399496 58722 367012 27892 14.7 7.6

1999-2000 475113 60408 444292 30211 12.7 6.8

2000-2001 558766 63883 526329 32632 11.4 6.2

The apparent reduction of gross NPA from 14.4% to 11.4% between 1998 and 2001provides little comfort, since this accomplishment is on account of credit growth, which was


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higher than the growth of Gross NPA and not through appreciable recovery of NPA. Ther e isneither reduction nor even containment of the threat.

The gross NPA and net NPA for PSBs as at 31.03.2001 are 12.39% and 6.74% are higherthan the figures for SCBs at 11.4%and 6.2%. Comparative figures for PSBs, SBI Group andNationalised Banks are as under.

Table -2 : NPA ofPSBs

(Amount in Crores) Year

TotalAdvance

s

GrossNPA

NetNPA

%-age ofGross

NPA tototal

advances

%-age ofNet

NPA tonet

advances >

1996-97 2442144357

72028

517.8 % 9.2 %

1997-98 2849714556

32123

216.0% 8.2%

1998-99 3253285171

02421

115.9% 8.1%

1999-2000 380077 53033 26188 14.00% 7.9%>

2000-2001 4421345477

32796

712.39% 6.74%

Table -3: NPA of State BankGroup..


TotalAdvances

GrossNPA

NetNPA

%-age ofGrossNPA to

totaladvances

%-age ofNet

NPA tonet

advances

1997-98 113360 15522 6829 14.57% 6.98 %

1998-99 118959 18641 7764 15.67% 7.74%

1999-2000 129253 19773 7411 14.08% 6.77%2000-2001 150390 20586 8125 12.73 % 6.26 %

Table -4: NPA of NationalisedBanks.


TotalAdvances

GrossNPA

NetNPA

%-age ofGrossNPA to

totaladvances

%-age ofNet

NPA tonet

advances

1997-98 166222 30130 14441 16.88 8.91

1998-99 188926 33069 15759 16.02 8.35

1999-2000 224818 33521 17399 13.99 7.80

2000-2001 264237 34609 16096 12.19 7.01

Further it is revealed that commercial banks in general suffer a tendency to understate theirNPA figures. There is the practice of 'ever -greening' of advances, through subtle techniques.As per report appearing in a national daily the banking industry has under-estimated its non-performing assets (NPAs) by whopping Rs. 3,862.10 Crore as on March 1997. The industryis also estimated to have under -provided to the extent of Rs 1,412.29 Crore. The worst"offender" is the public sector banking industry. Ninetee n nationalised banks along with the


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State Bank of India and its seven associate banks have underestimated their NPAs by Rs3,029.29 Crore. Such deception of NPA statistics is executed through the following ways.

y Failure to identify an NPA as per stipulated guidelines: There were instances of `sub -standard' assets being classified as `standard';

y Wrong classification of an NPA: classifying a loss' asset as a `doubtful' or `sub -

standard' asset; classifying a `doubtful' asset as a `sub -standard' asset.y Classifying an account of a credit customer as `substandard' and other accounts ofthe same credit customer as `standard', throwing prudential norms to the winds.

Essentially arising from the wrong classification of NPAs, there was a variation in the level ofloan loss provisioning actually held by the bank and the level required to be made. Thispractice can be logically explained as a desperate attempt on the part of the bankers,whenever adequate current earnings were not available to meet provisioning oblig ations.Driven to desperation and impelled by the desire not to accept defeat, they have chosen tomislead and claim compliance with the provisioning norms, without actually providing. Thisonly shows that the problem has swelled to graver dimensions.

The international rating agency Standard & Poor (S & P) conveys the gloomiest picture,

while estimating NPAs of the Indian banking sector between 35% to 70% of its totaloutstanding credit. Much of this, up to 35% of the total banking assets, as per the ratingagency would be accounted as NPA if rescheduling and restructuring of loans to make themgood assets in the book are not taken into account. However RBI has contested this dismalassessment. But the fact remains that the infection if left unchecked will e ventually lead towhat has been forecast by the rating agency. This invests an urgency to tackle this virus asa fire fighting exercise.

Financial institutions have not far lagged behind. NPAs of ten leading institutions havereported a rise of 11.89 per c ent, or Rs 1,929 Crore, to Rs 18,146 Crore during the yearended March 2000 from Rs 16,217 Crore last year. The NPA statistics of the three leadingFinancial Institutions for the last two years are given in Table -5 IDBI tops the list by notchingup bad loans worth Rs 7665 Crore by March 2000. In fact, its NPAs have gone up by Rs

1,185 Crore from Rs 6,490 Crore in the previous year. IFCI followed with NPAs of Rs 4,103Crore, but it reported fall of Rs 134 Crore from the previous year's level of Rs 4,237 Cror e.ICICI's NPAs went up to Rs 3,959 Crore from Rs 3,623 Crore in the previous year.

Table 5

NPA Statistics of the three

Major Term Lending

Institutions as at

31.03.2001. (Amount inCrores) Name of FI

Total

Loans

31.3.2000

Total

Loans

31.3.2001

NPA

31.3.2000

NPA-%

age

31.3.2000

NPA

31.3.2001

NPA-%

age

31.3.2001

IDBI 57099 56477 7665 13.4 8363 13.9

ICICI 52341 57507 3959 07.6 2782 05.2

IFCI 19841 18715 4103 20.7 3897 20.8

Emergence of NPA as an Alarming Threat to Nationalised Banks

NPA is a brought forward legacy accumulated over the past three decades, when prudentnorms of banking were forsaken basking by the halo of security provided by governmentownership. It is not wrong to have pursued social goals, but this does not justify r elegatingbanking goals and fiscal discipline to the background. But despite this extravagance themalaise remained invisible to the public eyes due to the practice of not following transparent


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accounting standards, but keeping the balance sheets opaque. T his artificially conveyedpicture of 'all is well' with PSBs suddenly came to an end when the lid was open with theintroduction of the prudential norms of banking in the year 1992 -93, bringing totaltransparency in disclosure norms and 'cleansing' the bal ance sheets of commercial banksfor the first time in the country.

How RBI Describes this New Development in its Web Site

In the peak crisis period in early Nineties, when the first Series of Banking Reforms wereintroduced, the working position of the Sta te-owned banks exhibited the severest strain.Commenting on this situation the Reserve Bank of India in its web -site has pointed out asunder:

"Till the adoption of prudential norms relating to income recognition, asset classification,provisioning and capital adequacy, twenty-six out of twenty-seven public sector banks werereporting profits (UCO Bank was incurring losses from 1989 -90). In the first post-reform year,i.e., 1992-93, the profitability of the PSBs as a group turned negative with as many as tw elvenationalised banks reporting net losses. By March 1996, the outer time limit prescribed forattaining capital adequacy of 8 per cent, eight public sector banks were still short of the

prescribed."

Consequently PSBs in the post reform period came to be classified under three categoriesas -

y healthy banks (those that are currently showing profits and hold no accumulatedlosses in their balance sheet)

y banks showing currently profits, but still continuing to have accumulated losses ofprior years carried forward in their balance sheets

y Banks which are still in the red, i.e. showing losses in the past and in the present.

Adverse Effects of NPA on the Working of Commercial Banks

NPA has affected the profitability, liquidity and competitive functioning of PSBs and finallythe psychology of the bankers in respect of their disposition towards credit delivery andcredit expansion.

Impact on Profitability

Between 01.04.93 to 31.03.2001Commercial banks incurred a total amount of Rs.31251Crores towards provisioning NPA. This has brought Net NPA to Rs.32632 Crores or 6.2% ofnet advances. To this extent the problem is contained, but at what cost? This costly remedyis made at the sacrifice of building healthy reserves for future capital adequacy. Theenormous provisioning of NPA together with the holding cost of such non -productive assetsover the years has acted as a severe drain on the profitability of the PSBs. In turn PSBs areseen as poor performers and unable to approach the market for raisi ng additional capital.Equity issues of nationalised banks that have already tapped the market are now quoted at adiscount in the secondary market. Other banks hesitate to approach the market to raise newissues. This has alternatively forced PSBs to borrow heavily from the debt market to buildTier II Capital to meet capital adequacy norms putting severe pressure on their profit margin,else they are to seek the bounty of the Central Government for repeated Recapitalisation.


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Considering the minimum cost of holding NPAs at 7% p.a. (reckoning average cost of fundsat 6% plus 1% service charge) the net NPA of Rs.32632 Crores absorbs a recurring holdingcost of Rs.2300 Crores annually. Considering the average provisions made for the last 8years, which works out to average of Rs.3300 Crores from annum, a sizeable portion of theinterest income is absorbed in servicing NPA. NPA is not merely non -remunerative. It is alsocost absorbing and profit eroding.

In the context of severe competition in the banking indu stry, the weak banks are atdisadvantage for leveraging the rate of interest in the deregulated market and securingremunerative business growth. The options for these banks are lost. "The spread is thebread for the banks". This is the margin between the cost of resources employed and thereturn there from. In other words it is gap between the return on funds deployed(Interestearned on credit and investments) and cost of funds employed(Interest paid on deposits).When the interest rates were directed by R BI, as heretofore, there was no option for banks.But today in the deregulated market the banks decide their lending rates and borrowingrates. In the competitive money and capital Markets, inability to offer competitive marketrates adds to the disadvantage of marketing and building new business.

In the face of the deregulated banking industry, an ideal competitive working is reached,

when the banks are able to earn adequate amount of non -interest income to cover theirentire operating expenses i.e. a posi tive burden. In that event the spread factor i.e. thedifference between the gross interest income and interest cost will constitute its operatingprofits. Theoretically even if the bank keeps 0% spread, it will still break even in terms ofoperating profi t and not return an operating loss. The net profit is the amount of the operatingprofit minus the amount of provisions to be made including for taxation. On account of theburden of heavy NPA, many nationalised banks have little option and they are unable tolower lending rates competitively, as a wider spread is necessitated to cover cost of NPA inthe face of lower income from off balance sheet business yielding non -interest income.

The following working results of Corporation bank an identified well man aged nationalisedbanks for the last two years and for the first nine months of the current financial year, will berevealing to prove this statement -

Table -6 (part-1) Performance ofCorporation Bank .......(Amount in Crores)..

Performance indicator

Year endedMar. 2000

Year endedMar. 2001

9 monthsApr.Decr.2001

Earnings - Non-interest 270.81 292.09 285.85

Operating expenses 303.99 341.36 280.52

Difference -33.18 -49.27 5.33

Non-interest income fully absorbs the operating expenses of this bank in the current financialyear for the first 9 months. In the last two financial years, though such income hassubstantially covered the operating expenses (between 80 to 90%) there is still a deficit left.Now what are the interest earnings and expenses of Co rporation Bank during this period?

Table -6 (part-1) Corporation Bank -InterestEarnings and Expense.. (Amount in

Crores) Performance indicator

Year endedMar. 2000

Year endedMar. 2001

9 monthsApr.Decr.2001

Earnings - Interest Income 1604.39 1804.54 1458.33

Exp.-Interest expenses 1146.09 1223.21 981.45

Interest spread 458.30 581.33 476.88

Operating Profit 425.12 482.21 532.06

Provisions 192.68 270.22 219.48


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Net Profit 232.44 261.84 262.73

The strength of Corporation Bank is identified by the following positive features:

i. It's sizeable earnings under of non -interest income substantially/totally meets its non -interest expenses.

ii. Its obligation for provisioning requirements is within bounds. (Net NPA/Net Advancesis 1.92%)

It is worthwhile to compare the aggregate figures of the 19 Nationalised banks for the yearended March 2001, as published by RBI in its Report on trends and progress of banking inIndia.

Table 7- Nationalised banks operational statistics..(Amount in Crores) Performance indicator

Year endedMar. 2000

Year endedMar. 2001

Earnings - Non-interest 6662.42 7159.41

Operating expenses 14251.87 17283.55

Difference -7589.45 -10124.14

Earnings - interest income 50234.01 56967.11

Exp.-Interest expenses 35477.41 38789.64Interest spread 14756.60 18177.47

Intt. On Recap bonds 1797.88 1795.48

Operating Profit 5405.27 6257.85

Provisions 4766.15 5958.24

Net Profit 639.12 299.61

Interest on Recapitalisation Bonds is an income earned from the Government, who hadissued the Recapitalisation Bonds to the weak banks to sustain their capital adequacy undera bailout package. The statistics above show the other weaknesses of the nationalisedbanks in addition to the heavy burden they have to bear for servicing NPA by way ofprovisioning and holding cost as under:

i. Their operating expenses are higher due to surplus manpower employed. Wagecosts to total assets is much higher to PSBs compared to new private banks orforeign banks.

ii. Their earnings from sources other than interest income are meagre. This is due tofailure to develop off balance sheet business through innovative banking products.

How NPA Affects the Liquidity of the Nationalised Banks?

Though nationalised banks (except Indian Bank) are able to meet norms of CapitalAdequacy, as per RBI guidelines, the fact that their net NPA in the average is as much as7% is a potential threat for them. RBI has indicated the ideal position as Zero percent NetNPA. Even granting 3% net NPA within limits of tolerance the nationalised banks are holding

an uncomfortable burden at 7.1% as at March 2001. They have not been able to buildadditional capital needed for business expansion through internal generations or by tappingthe equity market, but have resorted to II-Tier capital in the debt market or looking torecapitalisation by Government of India.

How NPA Affects the Outlook of Bankers towards Credit Delivery

The fear of NPA permeates the psychology of bank managers in the PSBs in enter tainingnew projects for credit expansion. In the world of banking the concepts of business and risks


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are inseparable. Business is an exercise of balancing between risk and reward. Accept justifiable risks and implement de-risking steps. Without accepting risk, there can be noreward. The psychology of the banks today is to insulate themselves with zero percent riskand turn lukewarm to fresh credit. This has affected adversely credit growth compared togrowth of deposits, resulting a low C/D Ratio around 5 0 to 54% for the industry.

The fear psychosis also leads to excessive security -consciousness in the approach towardslending to the small and medium sized credit customers. There is insistence on provision ofcollateral security, sometimes up to 200% value of the advance, and consequently due to afeeling of assumed protection on account of holding adequate security (albeit over -confidence), a tendency towards laxity in the standards of credit appraisal comes to the fore.It is well known that the existence of collateral security at best may convert the creditextended to productive sectors into an investment against real estate, but will not prevent theaccount turning into NPA. Further blocked assets and real estate represent the most illiquidsecurity and NPA in such advances has the tendency to persist for a long duration.

Nationalised banks have reached a dead -end of the tunnel and their future prosperitydepends on an urgent solution of this hovering threat.

The Unseen and Unperceived Edge of NPA

NPA surfaced suddenly in the Indian banking scenario, around the Eighties, in the midst ofturbulent structural changes overtaking the international banking institutions, and when theglobal financial markets were undergoing sweeping changes. We have already dis cussedthese changes in detail in an earlier Chapter. In fact after it had emerged the problem ofNPA kept hidden and gradually swelling unnoticed and unperceived, in the maze of defectiveaccounting standards that still continued with Indian Banks up to t he Nineties and opaqueBalance sheets.

In a dynamic world, it is true that new ideas and new concepts that emerge through suchchanges caused by social evolution bring beneficial effects, but only after levying a heavyinitial toll. The process of quickly integrating new innovations in the existing set -up leads toan immediate disorder and unsettled conditions. People are not accustomed to the newmodels. These new formations take time to configure, and work smoothly. The old is castaway and the new is fou nd difficult to adjust. Marginal and sub -marginal operators are sweptaway by these convulsions. Banks being sensitive institutions entrenched deeply intraditional beliefs and conventions were unable to adjust themselves to the changes. Theysuffered easy victims to this upheaval in the initial phase.

Consequently banks underwent this transition -syndrome and languished under distress andbanking crises surfaced in quick succession one following the other in many countries.Elaborating a cross-country description of this phenomenon a study by FICCI depicts asunder:

"Since the mid-eighties, banking crises have come to the forefront of economic analysis.Situations of banking distress have quickly intensified and in the process, have become oneof the main obstacles to stability to the financial system. According to Lindgren et.al. (1996),73 per cent of the member countries of the International Monetary Fund's (IMF) experiencedat least one bout of significant banking sector problems from 1980 to 1996. Moreimportantly, such crises have resulted in severe bank losses or public sector resolutioncosts. As Caprio and Klingebiel (1996) observe, such costs amounted to 10 per cent or moreof GDP in at least a dozen developing country episodes during the past 15 yea rs. Recentstudies by Honohan (1996) provide the estimated resolution costs of banking crises in


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developing and transition economies since 1980 are pegged at US $ 250 billion reinforcethis view."

But when the banking industry in the global sphere came out of this metamorphosis to re -adjust to the new order, they emerged revitalized and as more vibrant and robust units.Deregulation in developed capitalist countries particularly in Europe, witnessed a remarkable

innovative growth in the banking industry, wh ether measured in terms of deposit growth,credit growth, growth intermediation instruments as well as in network.

During all these years the Indian Banking, whose environment was insulated from the globalcontext and was denominated by State controls of directed credit delivery, regulated interestrates, and investment structure did not participate in this vibrant banking revolution. Sufferingthe dearth of innovative spirit and choking under undue regimentation, Indian banking waslacking objective and p rudential systems of business leading from early stagnation toeventual degeneration and reduced or negative profitability. Continued political interference,the absence of competition and total lack of scientific decision -making, led to consequences just the opposite of what was happening in the western countries. Imperfect accountingstandards and opaque balance sheets served as tools for hiding the shortcomings andfailing to reveal the progressive deterioration and structural weakness of the country's

banking institutions to public view. This enabled the nationalised banks to continue toflourish in a deceptive manifestation and false glitter, though stray symptoms of the brewingailment were discernable here and there.

The government hastily introduced the first phase of reforms in the financial and bankingsectors after the economic crisis of 1991. This was an effort to quickly resurrect the health ofthe banking system and bridge the gap between Indian and global banking development.Indian Banking, in particular PSBs suddenly woke up to the realities of the situation and toface the burden of the surfeit of their woes. Simultaneously major revolutionary transitionswere taking place in other sectors of the economy on account the ongoing economic reform sintended towards freeing the Indian economy from government controls and linking it tomarket driven forces for a quick integration with the global economy. Import restrictions weregradually freed. Tariffs were brought down and quantitative controls wer e removed. The

Indian market was opened for free competition to the global players. The new economicpolicy in turn revolutionalised the environment of the Indian industry and business and putthem to similar problems of new mixture of opportunities and ch allenges. As a result wewitness today a scenario of banking, trade and industry in India, all undergoing theconvulsions of total reformation battling to kick off the decadence of the past and to gain anew strength and vigour for effective links with the global economy. Many are stilllanguishing unable to get released from the old set -up, while a few progressive corporatesare making a niche for themselves in the global context.

During this decade the reforms have covered almost every segment of the fina ncial sector.In particular, it is the banking sector, which experienced major reforms. The reforms havetaken the Indian banking sector far away from the days of nationalization. Increase in thenumber of banks due to the entry of new private and foreign banks; increase in the

transparency of the banks' balance sheets through the introduction of prudential norms andnorms of disclosure; increase in the role of the market forces due to the deregulated interestrates, together with rapid computerisation and application of the benefits of informationtechnology to banking operations have all significantly affected the operational environmentof the Indian banking sector.

As banking in the country was deregulated and international standards came to be acceptedand applied, banks had to unlearn their traditional operational methods of directed credit,directed investments and fixed interest rates, all of which had led to deterioration in the


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same resultant factors. Containing quantum of NPA is therefore to be programmed by asector-wise strategy involving a role of the actively e ngaged participants who can tell wherethe boot pinches in each case. Business and industry has equal responsibility to acceptaccountability for containment of NPA. Many of the present defaulters were once trusted andvalued customers of the banks. Why have they become unreliable now, or have they?

The credit portfolio of a nationalised bank also includes a number of low -risk and risk-freesegments, which cannot create NPA. Small personal loans against banks' own deposits andother tangible and easily mark etable securities pledged to the bank and held in its custodyare of this category. Such small loans are universally given in almost all the branches andhence the aggregate constitutes a significant figure. Then there is food credit given to FCI forfood procurement and similar credits given to major public Utilities and Public SectorUndertakings of the Central Government. It is only the residual fragments of Bank credit thatare exposed to credit failures and reasons for NPA can be ascertained by scrutin ising thissegment.

Secondly NPA is not a dilemma facing exclusively the Bankers. It is in fact an all pervasivenational scourge swaying the entire Indian economy. NPA is a sore throat of the Indianeconomy as a whole. The banks are only the ultimate vict ims, where life cycle of the virus is

terminated.

Now, is not the Government an equal sufferer? What about the recurring loss of revenue byway of taxes, excise to the government on account of closure of several lakhs of erstwhilevibrant industrial units and inefficient usage of costly industrial infrastructure erected withconsiderable investment by the nation? As per statistics collected three years back there areover two and half million small industrial units representing over 90 percent of the totalnumber of industrial units. A majority of the industrial work force finds employment here andthe sector's contribution to industrial output is substantial and is estimated at over 35 percentwhile its share of exports is also valued to be around 40 percen t. Out of the 2.5 million, about10% of the small industries are reported to be sick involving a bank credit outstandingaround Rs.5000 to 6000 Crore, at that period. It may be even more now. These closed unitsrepresent some thousands of displaced workers previously enjoying gainful employment.

Each closed unit whether large, medium or small occupies costly developed industrial land.Several items of machinery form security for the NPA accounts should either be lying idle or junking out. In other words, la rge value of land, machinery and money are locked up inindustrial sickness. These are the assets created that have turned unproductive and theserepresent the real physical NPA, which indirectly are reflected in the financial statements ofnationalised banks, as the ultimate financiers of these assets. In the final analysis itrepresents instability in industry. NPA represents the woes of the credit recipients, in turntransferred and parked with the banks. What is the effect of the dismal situation on thepsychology of entrepreneurs intending fresh entry to business and industry?

Recognizing NPA as a sore throat of the Indian economy, the field level participants shouldfirst address themselves to find the solution. Why not representatives of industries an dcommerce and that of the Indian Banks' Association come together and candidly analyze

and find an everlasting solution heralding the real spirit of deregulation and decentralisationof management in banking sector, and accepting self -discipline and self-reliance? What arethe deficiencies in credit delivery that leads to its misuse, abuse or loss? How to checkmisuse and abuse at source? How to deal with erring Corporates? In short, the functionalstaff of the Bank along with the representatives of busine ss and industry have to accept acandid introspection and arrive at a code of discipline in any final solution. And preventiveaction to be successful should start from the credit -recipient level and then extend to thebankers. RBI and Government of India can positively facilitate the process by providingenabling measures. Do not try to set right industry and banks, but help industry and banks to


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set right themselves. The new tool of deregulated approach has to be accepted in solvingNPA.

Focus at Anomalies at the Credit Delivery Centre - A DetachedSurvey of NPA from within the Credit Agency

[The writer is a retired bank officer in senior management with four decades of past servicein one of the leading nationalised banks. He has overseen working of branches of the bankas Chief Inspector for three years and as Development Managers for two te rms. He had hadoccasion to study in-depth working of a number of branches big and small, as well asregional and zonal offices of the bank at the closest range with analytical precision. He hasalso served as Manager/Sr. Manager/Chief Manager in six large /very large branches in histenure. He was extensively engaged in multi -agency sponsored projects of social banking intwo States in the South. His propositions in this article are based on his field experience.Please also refer to pages titled "My Encounters with Corporate Corruption in my service" inthis context]

The Disorder & Confusion at the Credit Delivery Centres

NPA can be defined as failed credit. The service product has turned into sc rap. Creditdelivered is not put to productive application, but sunk into dead assets. But where has theprocess gone wrong? Has the credit delivered correctly, properly and sincerely? Searchobjectively for an answer examining credit delivery processes se quentially from within thebranch. Select a few branches with high -density NPA for your study and start methodicallyfrom the scratch. Has NPA surfaced due to defective product engineering by the designer(Banker) or due to misapplication of the product by the user (credit-customer), or due toeffects of the violently changing economic/ industrial /commercial environment?

The exact stage at which the failure has occurred, which causes NPA in the life cycle of aproject-finance can be identified in a post -mortem review. How a credit given to an eligibleand deserving customer for a viable project can ever become NPA, if it was efficientlyassessed and disbursed resulting in its successful completion and realisation of projectobjectives? Can it be only due to 'wilful default' by a credit customer at the last stage?Obviously if the credit is not allowed to a deserving, or eligible customer and it turns sticky,the financing bank is as much to be blamed as the customer. Similarly if the project financedis deficient and not viable or credit -worthy, it is a mistake of judicious assessment by thebank. The disbursement of project finance is not done efficiently, it may result in time/costover runs and lead to trouble to the financing institution. In all these cas es it is deficiency ofjob talents on the part of the banker, which creates NPAs. NPA can be arrested only throughinternal remedies, i.e. improving efficiency of credit assessment and credit deliveryoperations at the point of the financing bank in the fi rst instance. Followed by efficientutilisation credit disbursement by industry and trade.

Looking next at the customer what is the benefit or motive of the corporate customer to

wilfully default repayment? And why this tendency has surfaced amongst Indian corporatesin the last two decades? A project is deemed implemented successfully when it not onlyattains profitable turnover but also discharges the project -debt as per schedule. Debt defaultand successful entrepreneurship in business promotion do not g o together. The assetscreated in the project are encumbered to the lender and discharging the debt releases theassets from the banker's charge. The corporate customer proves his capacity and financialintegrity and he commands better recognition by the b anker for his future credit needs onlywhen the project is shown as self repaying its debts. Still why default takes place and thattoo wilfully? This is apparently against the laws of economics and law of human nature.


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Credit is a product of financial ser vice, which provides redeemable capital to industry andbusiness. Commencing with borrowed capital a viable project generates the source for itsrepayment and reaches the stand -alone or self-sustaining status. Primarily there are threestages in credit extension, its productive use and its repatriation. These are, credit delivery,credit utilization and loan liquidation. Unless you are successful in the earlier stage, you donot reach the next stage. Thus if the project report and the terms of loan sanction are nothandled realistically, the credit cycle will not pass on to the next stage of successful projectimplementation. If the project is not effectively implemented it is futile to aspire for repaymentin the normal course, without the loan becoming an NPA.

The credit customer need not have to search for a source to repay the loan. The source forrepayment is self-generated from within and made available in time schedules coincidingwith the repayment terms. The provision is in -built in the project struc ture. The bank-creditshould be for productive and self -redeemable projects and should thus be self -liquidating.This then is the test for a viable project and the grounds on which the banker accepts tofinance the same. The banker has to possess different knowledge resources and talents toefficiently handle credit -management at each stage. In particular the banker needs to havetwo primary attributes for successful credit extension. These are talent (appropriateknowledge and foresight) and integrity. The customer must possess entrepreneur ability and

integrity. We may call it as two 'C's (character and capacity) to be present commonly with thefinancier and promoter. These are the human factors. Additionally the project financed needsto possess two characteristics, technical feasibility and financial viability.

If the basic ingredients are lacking in the banker, the loan released by him will not beproductively employed and it may result in potential NPA. Decades back credit risk was notso extensive, when banking was operated purely on a security -oriented approach. Acceptand hold in your custody a marketable security and release the advance. Allow the activity tobe carried out by the customer. Release the security when repayment is made, and in caseof non-repayment dispose of the security and reimburse your exposure. It is almost zero riskoriented.

Subsequently when the country was industrialised in the 60s industry was protected by the

government policies. Imports were discouraged. Units enjoyed a cap tive demand withoutcompetition and hence there was no problem for the banker. But it is not so today, whenbanks are called upon to extend multiple types finance for diverse needs of capital forindustry, business and other economic activities open to glo bal competition. Character andcapacity are still the basic ingredient, but essence of these terms has acquired substantialadditional content and meaning.

The action or initiative is with the customer at the stage of the preparation of the project. It iswith the banker in project appraisal and loan sanction including the setting up of terms andconditions. If both act prudently the first stage is passed. In the second stage theimplementation responsibility is with the customer and controlling responsibil ity with thebanker. In the final stage it is mainly the responsibility of the customer. A healthy jointapproach promotes the cause of both, the absence of which can ruin either or both.

Your analysis of NPA study should indicate whether the roots of NPA lie in the first, secondor third stages of the life span of the service product. Wrong handling at any stage canobviously create NPA. Credit, which undergoes infant -mortality at the outset itself or after ashort span of time after trial production, is o n account of deficiency in credit assessment andcredit delivery. The loan is released, but not utilised for the purpose it was allowed and noassets are held or only negligible assets are seen. The seeds are sown but the plants neversprout and there is no question of the crops to harvest. This can be attributed to grossnegligence, inefficiency or lack of training and knowledge and finally lack of integrity in


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respect of the person(s) involved. These are the within factors responsible for accretion tothe pool of Bank's NPA burden - lack of talent and lack of integrity.

Failure in the second stage is generally on account of default on the part of the banker incarrying out his functions with foresight and wisdom. This goose will lay the golden eggs, butwithout waiting, if you cut the goose out of eagerness for a quick meal, it results in a sordid

plight for the person of hasty action. There are two manifestos for the branch manager, i.e.the Project Report and the Memorandum Of Loan Sanction by a higher authoritystipulating terms and conditions. In other words this is the outer limit of the delegatedauthority for the Bank Manager in the exercise of credit management with reference to thiscustomer. It is also a contract between the financing bank and the b orrowing customer. Theproject report is the source document and the loan sanction record is a derived instrument.The sanction should be based on the project report, and if this is not so and if the sanction isat variance, the project report must be revi sed and approved/accepted by all. Once a letterof sanction is received, the existence of the project report is forgotten and the assumptionscontained therein are totally ignored. No doubt the sanctioned terms represent the legalcontract between the credit customer and the banker, but the project report alone containsnucleus for the successful culmination of the activity and creating the source for repayment.During implementation of the project in the second stage involving disbursement of funds

progress may not take place as scheduled in the project. The situation needs a flexibleattitude on the part of the Bank manager, but if rigid adherence is resorted to the terms ofsanction, it brings adverse effects to the detriment of the interests of both the banker and thecredit customer. These problems were not felt so much earlier, when in the inflationaryeconomy, when the security financed was regularly appreciating in value, and marketing theproducts produced, even of inferior quality was never felt a p roblem in a captive andprotected market.

A concrete example can explain this. The project outlay is Rs.5 Lacs. Credit customer equityis Rs.2.0 Lacs and Bank loan Rs.3.0 Lacs. Credit customer's equity includes margin forworking capital Rs.50,000/ -.The Loan was to be released in January 1998 and the project tobe completed in the same year. The interest and first instalment to be repaid before March1999. Now there is delay initially in the bank completing the documents and other legal

formalities and the loan was released only in March 1998. On the credit customers part thereis delay of three months in the completion of the project. However the credit customer on hispart did bring Rs.25000 additionally. Now events as they have unfolded are at variance wi ththe assumptions in the project report. Thus the implementation report is different from theproject in certain details. As at 31st March 1999, when the project is still incomplete, thebank manager arbitrarily recovers the first instalment and interest, as per the terms ofsanction. If this happens, it is then woe to the project, which is still incomplete. The unitfinanced faces liquidity crunch due to contraction in working capital caused by term loanrepayment there from and is unable to either comple te the project or provide the margin andavail the working capital. Here the bankers switch to the 3rd stage in the life cycle, while thesecond stage is still incomplete. Recovery can come only from generated funds and not fromthe source of finance for t he project.

Two decades of regimented banking and directed approach to credit delivery has deprivedbank managers of the instinct skill and knowledge. Lack of structured career path andrestricted experience through vertical movement in the hierarchical ladder without ahorizontal exposure and without imparting training in organisation and businessmanagement needed for an understanding and for the interpretation of the current businessenvironment, are the sins of a blind promotion policy more oriented on subjectivity thanobjective merit assessment. Nationalised banking did not produce a spring of talentresources from within. Directive Inputs and course -direction came externally from RBI and


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Finance Ministry. Execution responsibility was delegated to the nationalised banks. Thesystem did not promote initiative and talent, but bred corruption and nepotism.

Before nationalisation banks were in the private sector. Indian banking developed on ethnicand regional set -up. Every community and every section wanted to start a bank. The entiresocial set up was based on the joint Hindu family culture and the business looked to class

banking for a select segment of society. Banking was not professionalised, as was majorbusiness and industry, which utilized bank finance. The tra der in the Mandi, the rice andcotton and oil miller did not believe that professional education is necessary for doingbusiness. So too did bankers. The average bank employee, including a part of the topexecutives did have no professional education or ed ucation in modern managementtechniques.

Bureaucratic approach and lack of talent in the service provider can also generate NPA.That happens when a project is grossly under -financed. It will also happen when the projectinitially is scrutinised at the lower level and found viable based on well -defined assumptions,but when finally sanctioned at a higher level, several stipulations like higher rate of interestor higher margin requirement on the credit customer stipulated like condition to raiseadditional internal finance by way of unsecured loans were included without looking into the

feasibility and sensitivity of the variations on the overall viability of the project.

Loyalty to the top man (CEO) and understandings his mind and acting as per his dictatesand desires is considered as a main service-ethics. Corporate management in India isgenerally a one-man dominated show. This is the legacy of the spirit of the patriarch in thedecade-old joint-family culture, which however has vastly dismantled. This ma nagementphilosophy is against modern management concepts of defining a goal and mission for theorganization. An individual is fragile and fickle minded. In the modern world, whereconsumerist motives predominates in the minds of all, his value systems ar e notdependable. Instead of loyalty to the mission and goals of the organization, it turns to beloyalty to the top boss, and to every top boss changing in intervals of 3 to 5 years.

This is the scene of Indian Banking struggling hard to transition from o ld primitive systems

and values to modern professional Business Ethics and Corporate Governance.

Diagnosis of the Root Cause and Tracing the Solution -- Self-Introspectionby Industry, Business and Banks

"The health of banks is determined by many factors, the most significant being a strongcapital base, adequate provisioning, the nature of investments made, the quality of assetmanagement, the skill and commitment of officials, quantity and quality of informationaldata, the internal incentive mechanisms and above all the nature of governmentalinterference, in particular by the monetary authorities of the country in question."

Anyone could with conviction and candour say that both the management of the nationalisedbanks, and business & industry are equa lly responsible for the emergence of NPA atalarming levels. The root causes are inefficiency and corruption. It is due to lack of capacityand character at both places. This inefficiency and corruption can be traced from the historyof the decadence that the social, political and economic institutions of our country underwentduring the last six decades commencing from the Second World War.

The Indian social system signifying the inherent values of business and industry underwentprogressive erosion in the last five or six decades, since the second World War. The era of


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pioneering philanthropic industrial barons like GD Birla or JRD Tata, wer e succeeded byannals of short-sighted industrialists, who desire more to get riches through any means ofmanipulation and speculative manoeuvres instead through bonafide efforts and honestmeans. Today we hear stories of Harshad Mehta -s and Ketan Parekh-s frequently. And it willalso be seen that in every scam in the country the banks are inextricably involved with asordid role.

The fall in the standards of public life is vividly brought out in the very first chapter titled"Discipline and its Qualities" in my Project Literature on "Integrity in Public Life & Services"as under:

" but in recent times old traditions are breaking very fastly. This tendency in oursocial values is aptly noticed and pointed out by Mr.K.Santhanam in his veryinformative Report , four decades ago. "In the pre -war and pre-independence era, aman was known in society by what he was. Today, he is known by what he has."

This is what Mr. Santhanam has to say:

"Thus, there has come about a certain amount of weakening of the old system of values

without its being replaced by an effective system of new values. The relative fixity of waysand aspirations of former times and the operation of a moral code tending tow ards austerity,frugality and simplicity of life profoundly influenced by the mechanism of social control andsocial responses. In the emerging Indian society with its emphasis on purposively initiatedprocess of urbanisation, along side of the weakening o f the social norms of the simplersociety signs are visible of materialism, growing impersonalism, importance of statusresulting from possession of money and economic power, group loyalties, intensification ofparochial affinity, unwillingness or inabilit y to deal with deviations from the highest standardsof political, economic and social ethics, profession of faith in the rule of law and disregard ofwhere adherence thereto is not convenient"

Diagnosis of Corruption Scene in India by Central Vigilance Co mmission

Dealing with the topic "Zero tolerance to corruption", the Commissioner of Central Vigilancehas diagnosed the corruption scenario prevailing in India as under:

"As we look at the corruption scene today, we find that we have reached this stage becausethe corrupting of the institutions in turn has finally led to the institutionalisation of corruption.As the Prime Minister pointed out, the failure to deal with corruption has bred contempt forthe law. When there is contempt for the law and this is combined with the criminalisation ofpolitics, corruption flourishes. It is the honest public servant who tries to implement the lawwho becomes a misfit under such a situation.

As of today, entire sections of our public life have become corrupt, as people like SS Gill in

his book THE PATHOLOGY OF CORRUPTION have pointed out. As I see it, there are fivekey players in our Indian corruption scene. These are the corrupt politician (neta), thcorrupt bureaucrat (babu), the corrupt business (lala), the corrupt NGO (jhola) and finallythe criminal (dada). There are five reasons why our system encourages corruption. Thesare (i) scarcity of goods and services, (ii) lack of transparency, (iii) red tape and delay dueto obsolete rules and procedures which are time consuming and encourage speed money,(iv) cushions of legal safety which have been laid down by various pronouncements of thcourts and CATs on the principle that everybody is innocent till proved guilty. The net resultis that the corrupt are able to engage the best lawyers and quibble their way through thsystem. (v) Finally, biradri or tribalism, where the corrupt public servants protect each other.


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We talk about people being thick as thieves not thick as honest men!

But why should this happen at all? The outlook of the individual, business men and publicservants got depraved in the aftermath of the 2nd World and subsequently on account ofGovernment assuming more and more powers to totally control the economic life of citizensin the country, inflating the powers of bureaucrats in the name of economic planning. The

resultant situation that developed is narrated in the same chapter referred earlier, as under:

The Second World War provided a fillip to the growth of corruption. It got an impetus in thepost war flush of money and consequent inflation. The subsequent period from theSeventies witnessed the start of the era of political corruption and criminalization of politics,of conducting or allowing corruption in the electoral process using money power and withlinks between criminals and politicians resulted in the total demoralisation of our public lives.Despite all this, what little progress we make to produce eminence intellectuals in our societyis solely on account of our ancient culture an d traditional family way of life. Today the goodmajority is dumb in public life. Many educated citizens do not even cast their franchise.

Growing indiscipline prevailing at the business and industry adversely affect the entiresociety and set pace to all our present social problems. Engaged in commercial or industrial

activities and dealing with vast resources, business enterprises as part of their activities buildwide interactions with the government and public authorities. Prompted by greed and thedesire for making quick or easy money, and possessed with vast resources garneredthrough black money hoarding, there is adequate scope for businessmen and industrialist inthis environment to use corrupt ways of getting their things achieved. Corruption is fu elled bygreed. It is an attempt to look for short cut means for getting quick money. Business andindustry promote corruption and public service thrives as the beneficiary of this evil source ofearnings. This phenomenon is well documented in Santhanam Co mmittee Report, asdescribed below.

Origin of Corruption in our Society - Analysis bySanthanam Committee Report (1964)

"Corruption can exist only if there is someone willing to corrupt and capable of corrupting.We regret to say that both this willingness and capacity to corrupt is found in a largmeasure in the industrial and commercial classes. The ranks of these classes have beeswelled by the speculators and adventurers of the war period. To these corruption is noonly an easy method to secure large unearned profits, but also the necessary means tenable them to be in a position to pursue their vocations or retain their position among theirown competitors. It is these persons who indulge in evasion and avoidance of taxesaccumulate large amounts of unaccounted money by various methods such as obtaininlicences in the names of bogus firms and individual's, trafficking in licences, suppressingprofits by manipulation of accounts to avoid taxes and other legitimate claims on profits,accepting money for transactions put through without accounting for it in bills and accounts(on-money) and under-valuation of transactions in immovable property. It is they who havecontrol over large funds and are in a position to spend considerable sums of money i

entertainment. It is they who maintain an army of liaison men and contract men, some owhom live, spend and entertain ostentatiously"

To cite a concrete example of the demoralisation has set in the country can be seen from theway the functioning of The Board for Industrial and Financial Reconstruction of sick industrialcompanies (special provisions) Act of 1985 is abused.


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[Excerpts from address by Deputy Governor (Shri G.P.Muniappan) at CII Banking

Summit 2002 at Mumbai on April 1, 2002 ]

"It is not Anymore Lenders' Problem alone but Equally that of Borrowers too!

"The high level of NPAs in banks and financial institutions has been a matter of grave

concern to the public as bank credit is the catalyst to the economic growth of the count ry andany bottleneck in the smooth flow of credit, one cause for which is the mounting NPAs, isbound to create adverse repercussions in the economy. NPAs are not therefore the concernof only lenders. I consider that forum like this, comprising of repres entatives of a majorsection of the beneficiaries of the financial system, should equally get concerned in a seriousway on what they can do to address the gravity of the NPA problem of banks. I would ratherurge them to lend a helping hand in the ongoing efforts of banks, and financial institutions torecover bad debts and arrest fresh accretions of NPAs.

Present Prudential Regulations

"The prudential norms on income recognition, asset classification and provisioning thereon,are implemented from the financial year 1992-93, as per the recommendation of the

Committee on the Financial System (Narasimham Committee I). These norms have broughtin quantification and objectivity into the assessment and provisioning for NPAs. We at thecentral bank constantly endeavour to ensure that our prescriptions in this regard are close tointernational norms. We are neither strict nor lax but just correct in tune with our needs andcapabilities.

"Under the prudential norms laid down by RBI

y Income should not be recognise d on NPAs on accrual basis but should be bookedonly when it is actually received in respect of such accounts.

y An asset is considered as "non-performing" if interest or instalments of principal dueremain unpaid for more than 180 days (the lag would get r educed to 90 days from

March 31, 2004 to conform to international norms). Any NPA would migrate fromsub-standard to doubtful category after 18 months (as against 12 months underinternational norms). It would get classified as loss asset if it is irrecove rable or onlymarginally collectible.

y The banks should make full provision for loss assets, 100 per cent of the unsecuredportion of the doubtful asset plus 20 to 50 per cent of the secured portion (dependingon the period for which the account is doubtfu l), and a general 10% (it is 20 per centunder international norms) of the outstanding balance in respect of sub -standardassets."

"Detailed guidelines have been issued by RBI in October 2000 on valuation and provisioningfor investment portfolio includin g credit substitutes"

Impact of NPAs on banks' profits and lending prowess

"The efficiency of a bank is not always reflected only by the size of its balance sheet but bythe level of return on its assets. NPAs do not generate interest income for the banks, but atthe same time banks are required to make provisions for such NPAs from their currentprofits.

NPAs have a deleterious effect on the return on assets in several ways -


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y They erode current profits through provisioning requirementsy They result in reduced interest incomey They require higher provisioning requirements affecting profits and accretion to

capital funds and capacity to increase good quality risk assets in future, andy They limit recycling of funds, set in asset -liability mismatches, etc

There is at times a tendency among some of the banks to understate the level of NPAs inorder to reduce the provisioning and boost up bottom lines. It would only postpone the < CBIand vigilance to management senior the subjecting besides internationally, cr edibility losingweak as branded getting like consequences, disastrous with banks of some in happenedeffect>

In the context of crippling effect on a bank's operations in all spheres, asset quality has beenplaced as one of the most important parameters i n the measurement of a bank'sperformance under the CAMELS supervisory rating system of RBI.

Movement of NPAs over the years

"A glance through the statistics on the movement of NPAs of public sector banks since

introduction of prudential norms in 1992 -1993 will help us to understand the extent to whichthe public sector banks have made progress in reducing their NPA levels

"The level of gross and net NPAs has been sliding down over the years. Gross NPA hadcome down from 23.18% in 1992-93 to 12.40% in 2000 -01. Net NPA also moved down from14.46% in 1993-94 to 6.74% in 2000-01. Still the NPA level can be considered of staggeringmagnitude in absolute terms costing the public sector banks more than Rs.5000 Croresannually by way of loss of interest income, bes ides servicing and litigation costs. To be fair, Ihave to state that a major portion of the NPAs was a legacy of the pre -prudential days, whenbanks were accounting for interest as income on accrual basis even when the underlyingadvances were not performing.

"It will be interesting to have a look at the movement of NPAs (gross and net), as apercentage of advances, group-wise over the last four years. This will give an idea of wherebanks, as different groups, stand in regard to their NPAs

"It may be observed that the malady of high level of NPAs eroding the profitability of banks isnot confined to public sector banks alone, but it is equally present in the private sector bankstoo. While some of the foreign banks loan portfolio had been affected by a few largeaccounts turning NPA, it is a matter of concern that some of the new private sector bankswhich started off on a clean slate had acquired so quickly such a large level of NPAs

Implications of NPAs - Supervisory action that may ariseon account of high level of NPAs

"One of the trigger points in the proposed Prompt Corrective Action (PCA) mechanism[which was widely circulated by RBI through the public domain] is the level of net NPAs.When the trigger point under the mechanism is activated by the performance of a bank, themandatory actions would follow by way of restriction on expansion of risk -weighted assets,submission and implementation of capital restoration plan, prior approval of RBI for openingof new branches and new lines of business, pa ying off costly deposits and special drive toreduce the stock of NPAs, review of loan policy, etc.


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Other implications

"The most important business implication of the NPAs is that it leads to the credit riskmanagement assuming priority over other aspects of bank's functioning. The bank's wholemachinery would thus be pre-occupied with recovery procedures rather than concentratingon expanding business.

"As already mentioned earlier, a bank with high level of NPAs would be forced to incurcarrying costs on a non-income yielding assets. Other consequences would be reduction ininterest income, high level of provisioning, stress on profitability and capital adequacy,gradual decline in ability to meet steady increase in cost, increased pressure on net interestmargin (NIM) thereby reducing competitiveness, steady erosion of capital resources andincreased difficulty in augmenting capital resources.

"The lesser appreciated implications are reputational risks arising out of greater disclosureson quantum and move ment of NPAs, provisions etc. The non -quantifiable implications canbe psychological like 'play safe' attitude and risk aversion, lower morale and disinclination totake decisions at all levels of staff in the bank.

Management of NPAs

"The quality and performance of advances have a direct bearing on the profitability andviability of banks. Despite an efficient credit appraisal and disbursement mechanism,problems can still arise due to various factors. The essential component of a sound NPAmanagement system is quick identification of non -performing advances, their containment atminimum levels and ensuring that their impingement on the financials is minimum.

"The approach to NPA management has to be multi -pronged, calling for different strategiesat different stages a credit facility passes through. RBI's guidelines to banks (issued in 1999)on Risk Management Systems outline the strategies to be followed for efficient managementof credit portfolio. I would like to touch upon a few essential aspects of NPA management in

this paper.

Excessive reliance on collateral has led Indian banks nowhere except to long drawn outlitigation and hence it should not be sole criterion for sanction. Sanctions above certain limitsshould be through Committee which can assume the status of an 'Approval Grid'.

"It is common to find banks running after the same borrower/borrower groups as we seefrom the spate of requests for considering proposals to lend beyond the prescribed exposurelimits. I would like to caution that runnin g after niche segment may be fine in the short runbut is equally fraught with risk. Banks should rather manage within the appropriate exposurelimits. A linkage to net owned funds also needs to be developed to control high leverages atborrower level.

"Exchange of credit information among banks would be of immense help to them to avoidpossible NPAs. There is no substitute for critical management information system andmarket intelligence.

We have come across cases of excellent appraisal and compliance wit h sanctionprocedures but no control at disbursement stage over compliance with the terms of sanction.To overcome this problem a mechanism for independent review of compliance with terms ofsanction has to be put in place.


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"Close monitoring of the account particularly the larger ones is the primary solution.Emerging weakness in profitability and liquidity, recessionary trends, recovery of instalments/ interest with time lag, etc., should put the banks on caution. The objective should be toassess the liquidity of the borrower, both present and future prospects. Loan reviewmechanism is a tool to bring about qualitative improvement in credit administration. Banksshould follow risk rating system to reveal the risk of lending. The risk -rating process shouldbe different from regular loan renewal exercise and the exercise should be carried out atregular intervals. It is not enough for banks to aspire to become big players without beingbacked by development of internal rating models. This is going to be a pr e-requisite underthe New Capital Adequacy framework and if a bank wants to be an international player, itshall have to go for such a system.

"Banks should ensure that sanctioning of further credit facilities is done only at higher levels. A quick review of all documents originally obtained and their validity should be made. Aphased programme of exit from the account should also be considered

Measures Initiated by RBI and Government of India for Reduction of NPAs

"As regards internal factors leading to NPAs, the onus rests with the banks themselves.This calls for organisational restructuring, improvement in managerial efficiency, skilupgradation for proper assessment of creditworthiness and a change in the attitude of thebanks towards legal action which is traditionally viewed as a measure of the last resort.These are the elements on the agenda of the second phase of reforms.[ Dr.Bimal Jalan, Governor, RBI, in a speech titled "Banking and Finance in the NewMillennium." delivered at 22nd Bank Economists Conference, New Delhi,15th February,2001]

Compromise settlement schemes

The RBI / Government of India have been constantly goading the banks to take steps forarresting the incidence of fresh NPAs and have also been creating legal and regulatoryenvironment to facilitate the recovery of existing NPAs of banks. More significant of them, Iwould like to recapitulate at this stage.

y The broad framework for compromise or negotiated settlement of NPAs advised byRBI in July 1995 continues to be in place. Banks are free to design and implementtheir own policies for recovery and write -off incorporating compromise and negotiatedsettlements with the approval of their Boards, particularly for old and unresolvedcases falling under the NPA category. The policy framework suggested by RBIprovides for setting up of an independent Settlement Advisory Committees headedby a retired Judge of the High Court to scrutinise and recommend compromiseproposals

y Specific guidelines were issued in May 1999 to public sector banks for one time nondiscretionary and non discriminatory settlement of NPAs of small sector. The schemewas operative up to September 30, 2000. [Public sector banks recovered Rs. 668crore through compromise set tlement under this scheme.]

y Guidelines were modified in July 2000 for recovery of the stock of NPAs of Rs. 5crore and less as on 31 March 1997. [The above guidelines which were valid up toJune 30, 2001 helped the public sector banks to recover Rs. 2600 crore bySeptember 2001]


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banks and FIs for recovery of their funds, as on 31st March every year. It is our experiencethat these measures had not contributed to any perceptible recoveries from the defaultingentities. However, they serve as negative basket of steps shutting off fresh loans to thesedefaulters. I strongly believe that a real breakthrough can come only if there is a change inthe repayment psyche of the Indian borrowers.

Recovery action against large NPAs

After a review of pendency in regard to NPAs by the Hon'ble Finance Minister, RBI hadadvised the public sector banks to examine all cases of willful default of Rs 1 crore andabove and file suits in such cases, and file criminal cases in regard to willful defaults. Boardof Directors are required to review NPA accounts of Rs.1 crore and above with specialreference to fixing of staff accountability.

On their part RBI and the Government are contemplating several supporting measuresincluding legal reforms, some of them I would like to highlight.

Asset Reconstruction Company:

An Asset Reconstruction Company with an authorised capital of Rs.2000 crore and initialpaid up capital Rs.1400 crore is to be set up as a trust for undertaking activities relating toasset reconstruction. It would negotiate w ith banks and financial institutions for acquiringdistressed assets and develop markets for such assets.. Government of India proposes togo in for legal reforms to facilitate the functioning of ARC mechanism

[For latest information on ARC formation pleas e refer to pages dealing with the subject ARC/SC Ordinance 2002

Legal Reforms

The Honourable Finance Minister in his recent budget speech has already announced the

proposal for a comprehensive legislation on asset foreclosure and securitisation. Sinceenacted by way of Ordinance in June 2002 and passed by Parliament as an Act inDecember 2002.

Corporate Debt Restructuring (CDR)

Corporate Debt Restructuring mechanism has been instituti onalised in 2001 to provide atimely and transparent system for restructuring of the corporate debts of Rs.20 crore andabove with the banks and financial institutions. The CDR process would also enable viablecorporate entities to restructure their dues o utside the existing legal framework and reducethe incidence of fresh NPAs. The CDR structure has been headquartered in IDBI, Mumbaiand a Standing Forum and Core Group for administering the mechanism had already beenput in place. The experiment however h as not taken off at the desired pace though more

than six months have lapsed since introduction. As announced by the Hon'ble FinanceMinister in the Union Budget 2002 -03, RBI has set up a high level Group under theChairmanship of Shri. Vepa Kamesam, Deput y Governor, RBI to review the implementationprocedures of CDR mechanism and to make it more effective. The Group will review theoperation of the CDR Scheme, identify the operational difficulties, if any, in the smoothimplementation of the scheme and sug gest measures to make the operation of the schememore efficient. For more information please refer the details of CDR Scheme given inanother page.


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Credit Information Bureau

Institutionalisation of information sharing arrangements through the newly formed CreditInformation Bureau of India Ltd. (CIBIL) is under way. RBI is considering therecommendations of the S.R.Iyer Group (Chairman of CIBIL) to operationalise the scheme ofinformation dissemination on defaults to the financial system. The main recommendations of

the Group include dissemination of information relating to suit -filed accounts regardless ofthe amount claimed in the suit or amount of credit granted by a credit institution as also suchirregular accounts where the borrower has given consent for disclosure. This, I hope, wouldprevent those who take advantage of lack of system of information sharing amongst lendinginstitutions to borrow large amounts against same assets and property, which had in nosmall measure contributed to the incremental NPAs of banks. More information on CIBILscheme given in a separate page.

Proposed guidelines on wilful defaul ts/diversion of funds

. Pursuant to the instructions of the Central Vigilance Commission for collection ofinformation on wilful defaults of Rs.25 lakhs and above by RBI and dissemination to thereporting banks and FIs, a scheme was framed by RBI with effe ct from 1st April 1999 under

which the banks and notified All India Financial Institutions were required to submit to RBIthe details of the wilful defaulters.

Accordingly, banks and FIs started reporting all cases of wilful defaults, which occurred orwere detected after 31st March 1999 on a quarterly basis. It covered all non -performingborrowal accounts with outstandings (funded facilities and such non -funded facilities whichare converted into funded facilities) aggregating Rs.25 lakhs and above identi fied as wilfuldefault by a Committee of higher functionaries headed by the Executive Director andconsisting of two GMs/DGMs. Banks/FIs were advised that they should examine all cases ofwilful defaults of Rs 1.00 crore and above for filing of suits and a lso consider criminal actionwherever instances of cheating/fraud by the defaulting borrowers were detected. In case ofconsortium/multiple lending, banks and FIs were advised that they report wilful defaults toother participating/financing banks also. Ca ses of wilful defaults at overseas branches wererequired be reported if such disclosure is permitted under the laws of the host country.

Further, considering the concerns expressed over the persistence of wilful default in thefinancial system in the 8th Report of the Parliament's Standing Committee on Finance onFinancial Institutions, the Reserve Bank of India, in consultation with the Government ofIndia, constituted in May 2001 a Working Group on Wilful Defaulters (WGWD) under theChairmanship of Shri S. S. Kohli, the then Chairman of the Indian Banks' Association, forexamining some of the recommendations of the Committee. The Group submitted its reportin November 2001. The recommendations of the WGWD were further examined by an InHouse Working Group constituted by the Reserve Bank. Accordingly, the Scheme wasfurther revised by RBI on May 30, 2002.

The Group submitted its report in November 2001. The recommendations of the WGWDwere further examined by an In House Working Group constituted by the Res erve Bank. Accordingly, the Scheme was further revised by RBI on May 30, 2002. The details of thescheme is provided on this website in another folder.

Corporate Governance

A Consultative Group under the chairmanship of Dr. A.S. Ganguly was set up by theReserve Bank to review the supervisory role of Boards of banks and financial institutions andto obtain feedback on the functioning of the Boards vis --vis compliance, transparency,


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disclosures, audit committees etc. and make recommendations for making the role of Boardof Directors more effective with a view to minimising risks and over -exposure. The Group isfinalising its recommendations shortly and may come out with guidelines fo r effective controland supervision by bank boards over credit management and NPA prevention measures.The report of the group is given and discussed in another page.

Special Mention Accounts - Additional Precaution at the Operating Level

A study at the behest of Board for Financial Supervision (BFS) was conducted by theReserve Bank by scanning relevant information/data obtained from a select group of banks,as also by holding discussions with bank officials, who manage NPAs at the policy level aswell as those who look after actual recovery, rehabilitation / revival, restructuring of accountsat the implementing level. On the basis of the study, we had suggested a framework ofrecommendations for preventing slippage of NPAs accounts from sub -standard todoubtful/loss category which had been circulated among banks for feedback and comments.Response from most banks to these recommendations has been positive and in addition,some useful suggestions too have been received, which have been taken into account at thetime of finalisation of the recommendations. In view of suggestions from some of the banks,our guidelines for categorising assets under special mention category may be taken as an

indicative framework for internal control purpose, for assets with potential weaknesses whichdeserves close attention and which can be resolved through timely remedial action.

Accordingly in a circular issued during September 2002, RBI has suggested to the banks tohave a new asset category - `special mention accounts' - for early identification of bad debts.This would be strictly for internal monitoring. Loans and advances overdue for less than onequarter and two quarters would come under this cat egory. Data regarding such accounts willhave to be submitted by banks to RBI.The details of the scheme are given in another folder

However, special mention assets would not require provisioning, as they are not classifiedas NPAs. Nor are these proposed to be brought under regulatory oversight and prudentialreporting immediately. The step is mainly with a view to alerting management to theprospects of such an account turning bad, a nd thus taking preventive action well in time. An

asset may be transferred to this category once the earliest signs of sickness/irregularities areidentified. This will help banks look at accounts with potential problems in a focused mannerright from the onset of the problem, so that monitoring and remedial actions can be moreeffective. Once these accounts are categorised and reported as such, proper topmanagement attention would also be ensured.

Borrowers having genuine problems due to temporary mismatch in funds flow or suddenrequirements of additional funds may be entertained at the branch level, and for this purposea special limit to tide over such contingencies may be built into the sanction process itself.This will prevent the need to route the additional funding request through the controllingoffices in deserving cases, and help avert many accounts slipping into NPA category.

Introducing a `special mention' category as part of RBI's `Inc ome Recognition and AssetClassification norms' (IRAC norms) would be considered in due course.

npa the unbridled virus and an emerging challenge to

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