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Non Performing Assets In Public Sector Banks
Soon after independence, as India embarked upon planned economic growth, like any other country, it needed a strong and efficient financial system to meet the multifarious requirements of credit and development. To achieve this objective it adopted a mixed pattern of economic development and devised a financial system to support such development. The success it achieved, particularly in taking banking to the masses and making the banking system a potent vehicle for furthering public policy has few parallels in the world.
The rapid growth of the banking system in terms of presence as well as penetration over the two decades immediately following nationalization of banks in 1969 was impressive. Even as the banking system’s branch network was growing at a fast pace, by the beginning of 1990s, it was realized that the efficiency of the financial system was not to be measured only by quantitative growth in terms of branch expansion and growth in deposits/advances or merely by fulfillment of social obligations of development. The Banking Industry has undergone a sea change after the first phase of economic liberalization in 1991 and hence credit management. While the primary function of banks is to lend funds as loans to various sectors such as agriculture, industry, personal loans, housing loans etc., in recent times the Banks have become cautious in extending loans reason being “NON PERFORMING ASSETS” (NPA’S).
An NPA is defined as a loan asset, which has ceased to generate any income for a bank whether in the form of interest or principal repayment. As per the prudential norms suggested by the Reserve Bank of India (RBI), a bank cannot book interest on an NPA on accrual basis. In other words, such interests can be booked only when it has been actually received. Therefore, this has become what is called as a ‘critical performance area’ of the banking sector as the level of NPAs affects the profitability of a bank.
A NPA is a loan or an advance where;
# Interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan,
# The account remains “out of order” in respect of an overdraft/ cash credit
# The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted
# The installment or interest remains overdue for two crop seasons in case of short duration crops and for one crop season in case of long duration crops
III. Categories Of NPA
The classification of assets of scheduled commercial bank. A debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The non performing asset is therefore not yielding any income to the lender in the form of principal and interest payments. A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. The gross margin represents the percent of total sales revenue that the company retains after incurring the direct costs associated with producing the goods and services sold by a company. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and obligations. Loans and advances given by banks to its customers is a asset to the bank. But, when repayment of interest and Principal is overdue, such asset is classified as NPA in the financial reports of banks. NPA is nothing but NON PERFORMANCE ASSETS. Simply it’s a Bad Debt to Bank.
# Substandard Assets – Which has remained NPA for a period less than or equal to 12 months.
# Doubtful Assets – Which has remained in the sub-standard category for a period of 12 months
# Loss Assets – where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly.
IV. Public Sector Banks
Public sector banks are the ones in which the government has a major holding. They are divided into two groups i.e. Nationalized Banks and State Bank of India and its associates. Among them, there are 19 nationalized banks and 8 State Bank of India associates. Public Sector Banks dominate 75% of deposits and 71% of advances in the banking industry. Public Sector Bank’s dominate commercial banking India. These can be further classified into:
1) State Bank of India
2) Nationalized banks
3) Regional Rural Banks
State bank group (eight banks): This consists of the State Bank of India (SBI) and Associate Banks of SBI. The Reserve Bank of India (RBI) owns the majority share of SBI and some Associate Banks of SBI. SBI has 13 head offices governed each by a board of directors under the supervision of a central board. The boards of directors and their committees hold monthly meetings while the executive committee of each central board meets every week.
In July 1969, 14 banks with a deposit base of Rs.50 crores or more were nationalized. Again in 1980, six more private banks were nationalized, bringing up the number to twenty. These Banks were:
(1) Bank of Baroda (2) Punjab National Bank (3) Bank of India (4) Canara Bank (5) Central Bank of India (6) Indian Bank (7) Indian Overseas Bank (8) Syndicate Bank (9) UCO Bank (10) Allahabad Bank (11) United Bank of India (12) Oriental Bank of Commerce (13) Corporation Bank (14) Vijaya Bank (15) Dena Bank (16) Bank of Maharashtra (17) Andhra Bank (18) Punjab & Sind Bank (19 New Bank of India (20) Corporation Bank.
Regional Rural Banks (RRBs): In 1975, the state bank group and nationalized banks were required to sponsor and set up RRBs in partnership with individual states to provide low-cost financing and credit facilities to the rural masses.
V. Ethical Issues And Factors Contributing To NPAs
# Poor Credit discipline and Inadequate Credit & Risk Management
# Diversion of funds by promoters Funding of non-viable projects and Inadequate mechanism to gather and disseminate credit information amongst commercial banks
# In the early 1990s PSBs started suffering from acute capital inadequacy and lower/ negative profitability. The parameters set for their functioning did not project the paramount need for these corporate goals.
# The banks had little freedom to price products, cater products to chosen segments or invest funds in their best interest
# Since 1970s, the PSB’s functioned as units cut off from international banking and unable to participate in the structural transformations and new types of lending products.
# Audit and control functions were not independent and thus unable to correct the effect of serious flaws in policies and directions
# Banks were not sufficiently developed in terms of skills and expertise to regulate the humongous growth in credit and manage the diverse risks that emerged in the process.
VI. Optimism With Respect To The Nonperforming Asset Problem
The NPAs of public sector banks were recorded at about Rs457 billion in 1998. By 1997/98 banks had managed to recover Rs250 billion and provisioned for Rs181.39 billion. But since new sets of loans go bad every year, the absolute figures could be increasing. About 70 percent of gross NPAs are locked up in “hard-core” doubtful, and loss assets, accumulated over years. Most of these are backed by securities, and, therefore, recoverable. But these are pending either in courts or with the Board for Industrial and Financial Reconstruction (BIFR). NPAs in Indian banks as a percentage of total assets are quite low. The NPA problem of banking institutions in India is exaggerated by deriving NPA figures based on percentage against risk assets instead of total earning assets.
The Indian banking system also makes full provisions and not net of collaterals as practiced in other countries.. Nevertheless, there is a general feeling that the NPA problem is manageable. Considerable attention is being devoted to this problem by RBI, individual banks, and shareholders (Government and private). With the increasing focus internationally on NPAs during the 1990s affecting the risk-taking behavior of banks, governments and central banks have typically reacted to the problem differently depending on the politico-economic system under which the banks operate.
Financial stability is considered as sine qua non of sustained and rapid economic progress. Among various indicators of financial stability, banks’ non-performing loan assumes critical importance since it reflects on the asset quality, credit risk and efficiency in the allocation of resources to productive sectors. A common perspective is that the problem of banks’ non-performing loans is ascribed to political, economic, social, technological, legal and environmental factors. It is in this context that this study has undertaken an empirical analysis for evaluating the impact of economic and financial factors on banks’ non-performing loans. The distinguishing feature of the study is that it provides a framework for analysis of underlying behavior of borrowers’ in terms of their loan repayments in response to lending terms of banks and other macroeconomic indicators.
Although public sector banks have recorded improvements in profitability, efficiency (in terms of intermediation costs) and asset quality in the 1990s, they continue to have higher interest rate spreads but at the same time earn lower rates of return, reflecting higher operating costs. Consequently, asset quality is weaker so that loan loss provisions continue to be higher. This suggests that, whereas, there is greater scope for enhancing the asset quality of banks, in general, public sector banks, in particular, need to reduce the operating costs further. The tenure of funds provided by banks either as loans or investments depends critically on the overall asset-liability position. An inherent difficulty in this regard is that since deposit liabilities of banks often tend to be of relatively shorter maturity, longterm lending could induce the problem of asset-liability mismatches. The problem of NPAs is related to several internal and external factors confronting the borrowers. The internal factors are diversion of funds for expansion/diversification/modernization, taking up new projects, helping/promoting associate concerns, time/cost overruns during the project implementation stage, business (product, marketing, etc.) failure, inefficient management, strained labour relations, inappropriate technology/technical problems, product obsolescence, etc., while external factors are recession, non-payment in other countries, inputs/power shortage, price escalation, accidents and natural calamities.
VII. Recommendations For Reducing NPAs
1) Effective and regular follow-up of the end use of the funds sanctioned is required to ascertain any embezzlement or diversion of funds. This process can be undertaken every quarter so that any account converting to NPA can be properly accounted for.
2) Combining traditional wisdom with modern statistical tools like Value-at-risk analysis and Markov Chain Analysis should be employed to assess the borrowers. This is to be supplemented by information sharing among the bankers about the credit history of the borrower. In case of new borrowers, especially corporate borrowers, proper analysis of the cash flow statement of last five years is to be done carefully.
3) A healthy Banker-Borrower relationship should be developed. Many instances have been reported about forceful recovery by the banks, which is against corporate ethics. Debt recovery will be much easier in a congenial environment.
4) Assisting the borrowers in developing his entrepreneurial skills will not only establish a good relation between the borrowers but also help the bankers to keep a track of their funds.
5) Countries such as Korea, China, Japan, and Taiwan have a well functioning Asset reconstruction/Recovery mechanism wherein the bad assets are sold to an Asset Reconstruction Company (ARC) at an agreed upon price. In India, there is an absence of such mechanism and whatever exists, it is still in nascent stage. One problem that can be accorded is the pricing of such loans. Therefore, there is a need to develop a common prescription for pricing of distressed assets so that they can be easily and quickly disposed.
6) Some tax incentives like capital gain tax exemption, carry forward the losses to set off the same with other income of the Qualified Institutional Borrowers (QIBs) should be granted so as to ensure their active participation by way of investing sizeable amount in distressed assets of banks and financial institutions.
7) So far the Public Sector Banks have done well as far as lending to the priority sector is concerned. However, it is not enough to make lending to this sector mandatory; it must be made profitable by sharply reducing the transaction costs. This entails faster embracing of technology and minimizing documentation.
8) Commercial Banks should be allowed to come up with their own measures to address the problem of NPAs. This may include waiving and reducing the principal and interest on such loans, or extending the loans, or settling the loan accounts. They should be fully authorized and they should be able to apply all the preferential policies granted to the asset management companies.
9) Another way to manage the NPAs by the banks is Compromise Settlement Schemes or One Time Settlement Schemes. However, under such schemes the banks keep the actual amount recovered secret. Under these circumstances, it is necessary to bring more transparency in such deals so that any flaw could be removed.
It is right time to take suitable and stringent measures to get rid of NPA problem. An efficient management information system should be developed. The bank staff involved in sanctioning the advances should be trained about the proper documentation and charge of securities and motivated to take measures in preventing advances turning into NPA. Public banks must pay attention on their functioning to compete private banks. Banks should be well versed in proper selection of borrower/project and in analyzing the financial statement.
This study attempted an empirical analysis of the nonperforming loans of public sector banks in India and investigated the response of NPLs to terms of credit, bank size and macroeconomic condition. The empirical analysis suggested that terms of credit variables have significant effect on the banks’ non-performing loans in the presence of bank size and macroeconomic shocks. Moreover, alternative measures of bank size could give rise to differential impact on bank’s non-performing loans. For instance, the bank size measured in terms of assets, has negative impact on NPAs. Thus, appropriate measure of size assumes importance. The empirical analysis suggests that asset measure of size could yield meaningful results relating to borrowers’ loan response.
The changes in the cost of credit in terms of expectation of higher interest rate induce increase in NPAs. On the other hand, factors like horizon of maturity of credit, better credit culture, and favorable macroeconomic and business conditions lead to lowering of NPAs.
# Reddy, Y.V., (2004), “Credit Policy, Systems, and Culture”, Reserve Bank of India Bulletin, March.
# A.K. Trivedi (2002), “Economic Reforms and Banking Scenario: An Analysis”, Indian Economic Panorama, A Quarterly Journal of
# Agriculture, Industry, Trade and Commerce, Special Banking Issue,
# McGoven, John (1998), ‘Why bad loans happen to good banks’, The Journal of Commercial Lending. Philadelphia: Feb 1993. Vol. 75, Issue. 6