Banking sector reforms in India has progressed promptly on aspects like interest
rate deregulation, reduction in statutory reserve requirements, prudential
norms for interest rates, asset classification, income recognition and
provisioning. But it could not match the pace with which it was expected to do.
The accomplishment of these norms at the execution stages without restructuring
the banking sector as such is creating havoc.
This research paper deals with the problem of having non-performing assets, the
reasons for mounting of non-performing assets and the practices present in other
countries for dealing with non-performing assets.
During pre-nationalization period and after independence, the banking sector
remained in private hands Large industries who had their control in the
management of the banks were utilizing major portion of financial resources of
the banking system and as a result low priority was accorded to priority
sectors. Government of India nationalized the banks to make them as an
instrument of economic and social change and the mandate given to the banks was
to expand their networks in rural areas and to give loans to priority sectors
such as small scale industries, self-employed groups, agriculture and schemes
To a certain extent the banking sector has achieved this mandate. Lead Bank
Scheme enabled the banking system to expand its network in a planned way and
make available banking series to the large number of population and touch every
strata of society by extending credit to their productive endeavours. This is
evident from the fact that population per office of commercial bank has come
down from 66,000 in the year 1969 to 11,000 in 2004. Similarly, share of
advances of public sector banks to priority sector increased form 14.6% in 1969
to 44% of the net bank credit. The number of deposit accounts of the banking
system increased from over 3 crores in 1969 to over 30 crores. Borrowed accounts
increased from 2.50 lakhs to over 2.68 crores.
Difficulties with the non-performing assets:
1. Owners do not receive a market return on their capital. In the worst case, if
the bank fails, owners lose their assets. In modern times, this may affect a
broad pool of shareholders.
2. Depositors do not receive a market return on savings. In the worst case if
the bank fails, depositors lose their assets or uninsured balance. Banks also
redistribute losses to other borrowers by charging higher interest rates. Lower
deposit rates and higher lending rates repress savings and financial markets,
which hampers economic growth.
3. Non performing loans epitomize bad investment. They misallocate credit from
good projects, which do not receive funding, to failed projects. Bad investment
ends up in misallocation of capital and, by extension, labour and natural
resources. The economy performs below its production potential.
4. Non performing loans may spill over the banking system and contract the money
stock, which may lead to economic contraction. This spillover effect can channelize through illiquidity or bank insolvency; (a) when many borrowers fail
to pay interest, banks may experience liquidity shortages. These shortages can
jam payments across the country, (b) illiquidity constraints bank in paying
depositors e.g. cashing their paychecks. Banking panic follows. A run on banks
by depositors as part of the national money stock become inoperative. The money
stock contracts and economic contraction follows (c) undercapitalized banks
exceeds the banks capital base.
Lending by banks has been highly politicized. It is common knowledge that loans
are given to various industrial houses not on commercial considerations and
viability of project but on political considerations; some politician would ask
the bank to extend the loan to a particular corporate and the bank would oblige.
In normal circumstances banks, before extending any loan, would make a thorough
study of the actual need of the party concerned, the prospects of the business
in which it is engaged, its track record, the quality of management and so on.
Since this is not looked into, many of the loans become NPAs.
The loans for the weaker sections of the society and the waiving of the loans to
farmers are another dimension of the politicization of bank lending.
Most of the depositor’s money has been frittered away by the banks at the
instance of politicians, while the same depositors are being made to pay through
taxes to cover the losses of the bank.
Comparative Study With Other Countries.
I. China: (a) Causes:
(i) The State Owned Enterprises(SOE’s) believe that there
the government will bail them out in case of trouble and so they continue to
take high risks and have not really strived to achieve profitability and to
improve operational efficiency. (ii) Political and social implications of
restructuring big SOE’s force the government to keep them afloat,(iii) Banks are
reluctant to lend to the private enterprises because while an NPA of an SOE is
financially undesirable, an NPA of a private enterprise is both financially and
politically undesirable,(iv) Courts are not reliable enforcement
Measures: (i) Reducing risk by strengthening banks, raising disclosure
standards and spearheading reforms of the SOE’s by reducing their level of debt,
(ii) Laws were passed allowing the creation of asset management companies,
foreign equity participation in securitization and asset backed securitization,
(iii) The government which bore the financial loss of debt ‘discounting’.
Debt/equity swaps were allowed in case a growth opportunity existed, (iv)
Incentives like tax breaks, exemption from administration fees and clear cut
asset evaluation norms were implemented.
The AMCs have been using leases, transfers, restructuring, debt- for-equity
swaps and asset securitization, among other methods, to dispose of
II. Korea: (a) Causes:
(i) Protracted periods of interest rate control and
allocations gave rise to an inefficient distribution of funds,(ii) Lack of
Monitoring ..... Banks relied on collaterals and guarantees in the allocation of
credit, and little attention was paid to earnings performance and cash flows,
(b) Measurers: (i) The speedy containment of systemic risk and the domestic
crunch problem with the injection of large public funds for bank
recapitalization, (ii) Corporate Restructuring Vehicles (CRVs) and Debt/Equity
Swaps were used to
facilitate the resolution of bad loans, (iii) Creation of the Korea Asset
Management Corporation (KAMCO) and a NPA fund to fund to finance the purchase of
NPAs, (iv) Strengthening of Provision norms and loan classification standards
forward-looking criteria (like future cash flows) were implemented; (v) The
objective of the central bank was solely defined as maintaining price stability.
The Financial Supervisory Commission (FSC) was created (1998) to ensure an
effective supervisory system in line with universal banking practices.
III. Japan: (a) Causes: (i) Investments was made real estate at high prices
during the boom. The recession caused prices to crash and turned a lot of these
loans bad, (ii) Legal mechanisms to dispose bad loans were time consuming and
NPAs remained on the balance sheet, (iii) Expansionary fiscal policy measures
administered to stimulate the economy supported industrial sectors like
construction and real estate, which may further exacerbated the problem, (iv)
Weak corporate governance coupled with a no-bankruptcy doctrine, (v) Inadequate
(b) Measures: (i) Amendment of foreign exchange control law (l997) and the
threat of suspension of banking business in case of failure to satisfy the
capital adequacy ratio prescribed, (ii) Accounting standards – Major business
groups established a private standard-setting vehicle for Japanese accounting
standards (2001) in line with international standards, (iii) Government Support
- The government’s committed public funds to deal with banking sector weakness.
III. Pakistan : (a) Causes: (i) Culture of
"zero equity" projects where there
was minimal due diligence was done by banks in giving loans coupled with
collusive lending and poor corporate governance, (ii) Poor entrepreneurship,
(iii) Chronic over-capacity/lack of competitive advantage,(iv) Directed lending
where the senior management of the public sector banks gave loans to political
heavy weights/ military commanders.
(b) Measures: (i) The top management of the banks was changed and appointment of
independent directors in the board of directors , (ii) aggressive settlements
were done by banks with their defaulting borrowers at values well below the
actual debt outstanding and/or the amount awarded through the court process
i.e., large haircuts/ write offs, (iii) setting up of Corporate and Industrial
Restructuring Corporation (CIRC) to take over the non-performing loan portfolios
of nationalized banks on certain agreed terms and conditions and issue
government guaranteed bonds earning market rates of return,(iv) The Banking
Companies (Recovery of Loans, Advances, Credits and Finances) Act, 1997 was
introduced in February 1997. Special banking courts have been established under
this Act to facilitate the recovery of non-performing loans and advances from
I would suggest 3 ways of solving this problem of NPAs. They are (i)
recapitalization of banks with Government aid, (ii) disposal and write off of NPAs, (iii) increased regulation.