CHAPTER-1

INTRODUCTION

1.1 Meaning

1.2 Significance of the Topic

1.3 Concept and Background of Non-Performing Assets

1.4 Instructions, Guidelines and Prudential Norms of Reserve Bank of India

1.5 Appraisal of Managerial Capability of a Borrower : A Key Element inCredit Decisions

1.6 About the Present Study

1.6.1 Problem to be Investigated

1.6.2 Significance of the Study

1.6.3 Objectives of the Study

1.6.4 Hypothesis

1.6.5 Period of the Study

1.6.6 Units of the Study

1.6.7 Plan of Research Design

1.6.8 Review of Literature

1.6.9 Scope of the Study

1.6.10 Limitations of the Study

Banking in India in the modern sense originated in the last decades

Estelar

of the 18th century. Reserve Bank of India was established in 1935. In

1969, the Indian government nationalised all the major banks that it did

not already own and these have remained under government

ownership. They are run under a structure know as ‘profit-making public

sector undertaking’ (PSU) and are allowed to compete and operate as

commercial banks.

The Indian banking sector is made up of four types of banks, as

well as the PSUs and the state banks, they have been joined since

1990s by new private commercial banks and a number of foreign banks.

Banking in India was generally fairly mature in terms of supply, product

range and reach-even though reach in rural India and to the poor still

remains a challenge.

The next stage for the Indian banking has been set up with the

proposed relaxation in the norms for Foreign Direct Investment, where

all Foreign Investors in banks may be given voting rights which could

exceed the present cap of 10%, at present it has gone up to 74% with

some restrictions.

The new wave ushered in a modern outlook and tech-savvy

methods of working for traditional banks. All this led to the retail boom in

India. People not just demanded more from their banks but also

received more. Up to this, it was fair, but down grade in its recovery

create non-performing assets which is a matter of worry.

1.1 Meaning

1

Estelar

Non Performing Asset means an asset or account of borrower,

which has been classified by a bank or financial institution as

sub-standard, doubtful or loss asset, in accordance with the directions or

guidelines relating to asset classification issued by The Reserve Bank of

India. Banks usually classify as non-performing assets any commercial

loans which are more than 90 days overdue and any consumer loans

which are more than 180 days overdue. More generally, an asset which

is not producing income is called as non-performing asset.

Ninety days overdue : With a view to moving towards international

best practices and to ensure greater transparency, it has been decided

to adopt the ‘90 days overdue’ norm for identification of NPAs, from the

year ending March 31, 2004.1 Accordingly, with effect form March 31,

2004, a non-performing asset (NPA) shall be a loan or an advance

where:

1. interest and /or installment of principal remain overdue for a

period of more than 90 days in respect of a Term Loan.

2. the account remains ‘out of order’ for a period of more than 90

days, in respect of an overdraft/ cash credit (OD/CC).

3. the bill remains overdue for a period of more than 90 days in

the case of bills purchased or discounted.

4. interest and/ or installment of principal remains overdue for two

harvest seasons but for a period not exceeding two half years

in the case of an advance granted for agricultural purpose.

Out of order : An account treated as ‘out of order’ if the outstanding

2

Estelar

balance remains continuously in excess of the sanctioned limit /drawing

power. In case where the outstanding balance in the principal operating

account is less than the sanctioned limit/ drawing power, but there are

no credits continuously for six months (the ‘time limit’ is for the study

period of present study from 2007-08 to 2011-12, otherwise The

Reserve Bank of India issued a master circular DBOD.No.BP.BC.21

/21.04.048/2010-11 on dated July 1, 2010 named as Master Circular -

Prudential Norms on income Recognition, Asset Classification and

Provisioning pertaining to Advances in which this ‘time limit’ has been

reduced to 90 days) as on the date of balance sheet or credits are not

enough to cover the interest debited during the same period, these

account should be treated as ‘out of order’.2

1.2 Significance of the Topic

A strong banking sector is important for flourishing economy. The

failure of the banking sector may have an adverse impact on other

sectors. Non-performing assets are one of the major concerns for banks

in India.

NPAs reflect the performance of banks. A high level of NPAs

suggests high probability of a large number of credit defaults that affect

the profitability and net-worth of banks and also erodes the value of the

asset. The NPAs growth involves the necessity of provisions, which

reduces the overall profits and shareholders value.

The issue of Non Performing Assets has been discussed at length

3

Estelar

for financial systems all over the world. The problem of NPAs is not only

affecting the banks but also the whole economy. In fact, high level of

NPAs in Indian banks is nothing but a reflection of the state of health of

the industry and trade.

1.3 Concept and Background of Non-Performing Assets

NPA surfaced suddenly in the Indian banking scenario, around the

Eighties, in the midst of turbulent structural changes overtaking the

international banking institutions, and when the global financial markets

were undergoing sweeping changes. In fact after it had emerged, the

problem of NPA kept hidden and gradually swelling unnoticed and

unperceived, in the maze of defective accounting standards that still

continued with Indian Banks up to the Nineties and opaque

Balance-sheets.3

In a dynamic world, it is true that new ideas and new concepts that

emerge through such changes caused by social evolution bring

beneficial effects, but only after levying a heavy initial toll. The process

of quickly integrating new innovations in the existing set-up leads to an

immediate disorder and unsettled conditions. People are not

accustomed to the new models. These new formations take time to

configure, and work smoothly. The old is cast away and the new

formations take time to configure, and work smoothly. Marginal and

sub-marginal operators are swept away by these convulsions. Banks

being sensitive institutions entrenched deeply in traditional beliefs and

conventions were unable to adjust themselves to the changes they

4

Estelar

suffered easy victims to this upheaval in the initial phase.4

Consequently, banks underwent this transition-syndrome and

languished under distress and banking 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

as under :

“Since the mid-eighties, banking crises have come to the forefront

of economic analysis. Situation of banking distress have quickly

intensified and in the process, have become one of 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) experienced at lest one bout of significant banking sector

problem from 1980 to 1996. More importantly, such crises have resulted

in severe bank losses or public sector resolution costs. As Caprio and

Klingebiel (1996) observe, such costs amounted to 10 per cent or more

of GDP in at least a dozen developing country episodes during the past

15 years. Recent studies by Honohan (1996) provide the estimated

resolution costs or banking crises in developing and transition

economies 1980.5

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, whether measured in terms of

5

Estelar

deposit growth, credit growth, growth intermediating instruments as well

as in network.

During all these years, the Indian Banking, whose environment was

insulated from the global context and was denominated by state controls

of directed credit delivery, regulated interest rates, and investment

structure did not participate in this vibrant banking revolution. Suffering

the dearth of innovative spirit and choking under undue regimentation,

Indian banking was lacking objective and prudential systems of

business leading from early stagnation to eventual 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 accounting standards and opaque balance

sheets served as tools for hiding the shortcomings and failing to reveal

the progressive deterioration and structural weakness of the country’s

banking institutions to public view. This enabled the nationalized banks

to continue to flourish a deceptive manifestation and false glitter, though

stray symptoms of the brewing ailment were discernible here and there.6

The government hastily introduced the first phase of reforms in the

financial and banking sectors after the economic crisis of 1991. This was

an effort to quickly resurrect the health of the banking system and bridge

the gap between Indian and global banking development. Indian

Banking, in particular, Public Sector Banks suddenly woke up to the

realities of the situation and to face the burden of the surfeit of their

woes. Simultaneously major revolutionary transitions were taking place

6

Estelar

in other sectors of the economy on account the ongoing economic

reforms intended towards freeing the Indian economy from government

controls and linking it to market driven forces for a quick integration with

the global economy. Import restrictions were gradually freed. Tariffs were

brought down and quantitative controls were removed. The Indian

market was opened for free competition to the global players. The new

economic policy in turn, revolutionarises the environment of the Indian

industry and business and put them to similar problems of new mixture

of opportunities and challenges. As a result, we witness today a

scenario of banking, trade and industry in India, all undergoing the

convulsions of to the reformation battling to kick off the decadence of the

past and to gain a new strength and vigor for effective links with the

global economy. Many are still languishing unable to get released from

the old set-up, while a few progressive corporate are making a niche for

themselves in the global context.7

During this decade, the reforms have covered almost every

segment of the financial sector. In particular, it is the banking sector,

which experienced major reforms. The reforms have taken the Indian

banking sector far away from the days of nationalization. Increase in the

number 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 and norms of disclosure; increase in the

role of the market forces due to the deregulated interest rates, together

with rapid computerization and application of the benefits of information

technology to banking operations have all significantly affected the

7

Estelar

operational environment of the Indian banking sector.8

As banking in the country was deregulated and international

standards came to be accepted and applied, banks had to unlearn their

traditional operational methods of directed credit, directed investment

and fixed interest rates, all of which had led to deterioration in the quality

of loan portfolios, inadequacy of capital and the erosion of profitability.

Banks have now an entirely different environment under which to

operate, to innovate and thrive in a highly competitive market and their

success depended on their ability to act and adopt to market changes.

These called for new strategies, different from those that related to

regulated banking in a captive environment.9

In the background of these complex changes when the problem of

NPA was belatedly recognized for the first time at its peak velocity during

1992-93, there was resultant chaos and confusion. As the problem in

large magnitude erupted suddenly banks were unable to analyze and

make a realistic or complete assessment of the surmounting situation. It

was not realized that the root of the problem of NPA was centered

elsewhere in multiple layers, as much outside the banking system, more

particularly in the transit end economy of the country, as within Banking

is not a compartmentalized and isolated sector declined from the rest of

the economy. As has happened elsewhere in the world, a distressed

national economy shifts a part of its negative results to the banking

industry. In short, banks are made ultimately to finance the losses

incurred by constituent industries and businesses. The unpreparedness

and structural weakness of our banking system to act to the emerging

8

Estelar

scenario and derrick itself to the challenges thrown by the new order,

dying to switch over to globalisation were only aggravating thrown by the

new order dying to switch over to globalisation were only aggravating

the crisis. Partial perceptions and hasty judgments led to a policy of

ad-hoe-ism, which characterized the approach of the authorities during

the last two-decades towards finding, solutions to banking ailments and

dismantling recovery impediments. Continuous concern was expressed.

Repeated correctional efforts were executed, but positive results were

evading. The problem was defying a solution.10

But why? The threat of NPA was being surveyed and summarized

by RBI and Government of India from a remote perception looking at

bird’s eye-view on the banking industry as a whole declined form the

rest of the economy. A bird’s eye view is distinct, extensive and even

sharp, but it is limited to the view appearing at the surface or top-layer. It

is not an exhaustive or in-depth view. Restricted merely as a top-layer

view it is partial and is not even a top-to-bottom view, where a

bottom-to-top- view alone can enlighten the correct contributing

factors.11

Flying at a great height the bird can of-course survey a wide area,

but it perceives only a telescopic view of the roof-top and not the

contents that exist inside the several structures. A simple look at the

whole provides summarized perception. But, it is not homogeneous

whole that is being perceived. RBI looks at the banking industry’s

average on a macro basis, consolidating and tabulating the data

submitted by different institutions. It has collected extensive statistics

9

Estelar

about NPAs in different financial sectors like commercial banks, financial

institutions, RRBs, urban cooperatives, NBFC etc. But still it is a distant

view of one outside the system and not the felt view of a suffering

participant. Individual banks inherit different cultures and they finance

diverse sectors of the economy that do not possess identical attributes.

There are distinct diversities as among the Public Sector Banks

themselves, between different geographical regions and between

different types of customers using bank credit. There are three weak

nationalized banks that have been identified. But there are also

correspondingly two better performing banks like Corporation Bank and

Oriental Bank of Commerce. There are also banks that have

successfully contained NPA and brought it to single digit like Syndicate

(Gross NPA 7.87%) and Andhra (Gross NPA 6.13%). The scenario is not

so simple to be generalized for the industry as a whole to prescribe a

ready-made package of a common solution for all banks and for all

times.12

Similarly, NPA concerns of individual Banks summarized as a

whole and expressed as an average for the entire bank cannot convey a

dependable picture. It is being statistically stated that bank X or Y has

12% gross NPA. But if we look down further within that Bank there are a

few pockets possessing bulk segments of NPA ranging between 50% to

70% gross, which should consequently convey that there should also be

several other segments with 3 to 5% or even NIL (0%) NPA, averaging

the bank’s whole performance to 12%.13

10

Estelar

1.4 Instructions, Guidelines and Prudential Norms of

Reserve Bank of India

In order to have all current instructions on the subject at one place,

the Reserve Bank of India had issued a Master Circular on the

captioned subject, which is now updated up to 30th June 2009. It may be

noted that the Master Circular consolidates and updates all the

instructions contained in the notifications vide Notification No.

DNBS.2/CGM(CSM) -2003, dated April 23, 2003 read with Company

Circular DNBS (PD) CC.1/SCRC/10.30/2002-2003 dated April 23, 2003.

The Reserve Bank of India, having considered it necessary in the

public interest, and being satisfied that, for the purpose of enabling the

Reserve Bank to regulate the financial system to the advantage of the

country and to prevent the affairs of any Securitisation Company or

Reconstruction Company from being conducted in a manner detrimental

to the interest of investors or in any manner prejudicial to the interest of

such Securitisation Company or Reconstruction Company, it is

necessary to issue the guidelines and directions relating to registration,

measures of asset reconstruction, functions of the company, prudential

norms, acquisition of financial assets and matters related thereto, as set

out below hereby, in exercise of the powers conferred by Sections 3, 9,

10 and 12 of the Securitisation and Reconstruction of Financial Assets

and Enforcement of Security Interest Act, 2002, issues to every

Securitisation Company or Reconstruction Company, the guidelines and

directions hereinafter specified.14

Short title and commencement

11

Estelar

These guidelines and directions shall be known as ‘The

Securitisation Companies and Reconstruction Companies (Reserve

Bank) Guidelines and Directions, 2003’. They shall come into force with

effect from April 23, 2003.15

Applicability of the Directions

The provisions of these guidelines and directions shall apply to

Securitisation Companies or Reconstruction Companies registered with

the Reserve Bank of India under Section 3 of the Securitisation and

Reconstruction of Financial Assets and Enforcement of Security Interest

Act, 2002.

Definitions

‘’Non-performing Asset‘’ (NPA) means an asset in respect of which:

(a) Interest or principal (or installment thereof) is overdue for a period of

180 days or more from the date of acquisition or the due date as per

contract between the borrower and the originator, whichever is later

(Amended as 90 days from 31st March 2004); (b) interest or principal (or

installment thereof) is overdue for a period of 180 days or more from the

date fixed for receipt thereof in the plan formulated for realisation of the

assets referred to in paragraph 7(1)(6) herein (Amended as 90 days

from 31st March 2004); (c) interest or principal (or installment thereof) is

overdue on expiry of the planning period, where no plan is formulated

for realisation of the assets referred to in paragraph 7(1)(6) herein; or (d)

any other receivable, if it is overdue for a period of 180 days or more in

the books of the Securitisation Company or Reconstruction Company

(Amended as 90 days from 31st March 2004).

12

Estelar

Permissible Business

A Securitisation Company or Reconstruction Company shall

commence/undertake only the securitisation and asset reconstruction

activities and the functions provided for in Section 10 of the Act. A

Securitisation Company or Reconstruction Company shall not raise

moneys by way of deposit.16

Securitisation

Issue of Security Receipts : A Securitisation Company or

Reconstruction Company shall give effect to the provisions of Sections

7(1) and (2) of the Act through one or more trusts set up exclusively for

the purpose. The Securitisation Company or Reconstruction Company

shall transfer the assets to the said trusts at the price at which those

were acquired from the originator.17

Requirement as to capital adequacy

(1) Every Securitisation Company or Reconstruction Company

shall maintain, on an ongoing basis, a capital adequacy ratio, which

shall not be less than fifteen percent of its total risk weighted assets. The

risk-weighted assets shall be calculated as the weighted aggregate of

on balance sheet and off balance sheet items as detailed hereunder:

Table 1.1

Weighted Risk Assets

On-Balance Sheet items Percentage risk

weight

13

Estelar

(a) Cash and deposits with scheduled commercialbanks

0

(b) Investments in Government securities 0

(c) Other assets 100

Off-Balance Sheet Items

All Contingent Liabilities 50

(2) Shares held in other Securitisation Companies or

Reconstruction Companies shall not attract any risk weight.

Deployment of Funds

(i) A Securitisation Company or Reconstruction Company, may as a

sponsor and for the purpose of establishing a joint venture, invest in the

equity share capital of a Securitisation Company or Reconstruction

Company formed for the purpose of asset reconstruction;

(ii) A Securitisation Company or Reconstruction Company may

deploy any surplus available with it only in Government securities and

deposits with scheduled commercial banks in terms of a policy framed in

this regard by its Board of Directors;

(iii) No Securitisation Company or Reconstruction Company shall

invest out of its owned fund in land and building, provided that this

restriction will not apply to funds borrowed as also to owned fund in

excess of the minimum prescribed.

Provisioning requirements : Every Securitisation Company or

Reconstruction Company shall make provision against Non Performing

Assets, as under18: -

14

Estelar

Table 1.2

Provision against Non Performing Assets

Asset Category Provision Required

Substandard Assets A general provision of 10% of theoutstanding;

Doubtful Assets (i) 100% provision to the extent the assetis not covered by the estimated realisable value of security;(ii) In addition to item (i) above, 50% ofthe remaining outstanding.

Loss Assets The entire asset shall be written off.(If, for any reason, the asset is retained in the books, 100% thereof shall beprovided for).

Investments

All investments should be valued at lower of cost or realisable

value. Where market rates are available, the market value would be

presumed to be the realisable value and in cases where market rates

are not available, the realisable value should be the fair value. However,

investments in other registered Securitisation Company or

Reconstruction Company shall be treated as long term investments and

valued in accordance with the Accounting Standards and guidance

notes issued by the Institute of Chartered Accountants of India.

Income recognition

(i) The income recognition shall be based on recognised

accounting principles;

15

Estelar

(ii) All the Accounting Standards and Guidance Notes issued by the

Institute of Chartered Accountants of India shall be followed in so far as

they are not inconsistent with the guidelines and directions contained

herein;

(iii) Interest and any other charges in respect of all the NPAs shall

be recognised only when they are actually realised. Any such unrealised

income recognised by a Securitisation Company or Reconstruction

Company before the asset became non-performing and remaining

unrealised shall be derecognised.19

Internal Audit

Every Securitisation Company or Reconstruction Company shall

put in place an effective Internal Control System providing for periodical

checks and review of the asset acquisition procedures and asset

reconstruction measures followed by the company and matters related

thereto.

These Guidelines and Directions of Reserve Bank of India are quite

explanatory and clear. Also, it seems that if these are followed strictly by

Public Sector Banks, other banks and financial institutions,

Non-Performing Assets will not be a huge problem which now affecting

the whole economic system. But there are several factors due to which it

is practically not possible and the amount of NPAs is getting increment.

Prudential Norms on Income Recognition, Asset Classification and

Provisioning on Advances

16

Estelar

Prudential norms on income recognition, asset classification and

provisioning (IRAC norms) pertaining to advances portfolios of banks

were introduced for the first time by Reserve Bank of India during

financial year 1992-93 i.e. year ended 31st March 1993 in line with the

international practices.

The prudential norms are formulated on the basis of objective

criteria rather than on any subjective consideration. This has brought in

uniform and consistent application of the norms and greater trans-

parency in published accounts of banks.

Reserve Bank of India has been issuing Master Circulars on

prudential norms for past few years. Last Master circular on prudential

norms pertaining to advances was issued by Reserve Bank of India on

1st July 2010.20

Asset Type

Standard Asset : The account is not non-performing and does not

carry more than normal risk attached to the business.

Non-Performing Asset (NPA) : An asset becomes NPA when it

ceases to generate income for the bank. This would mean that interest,

which is debited to borrower’s account, has to be realised by the bank.

An account has to be classified as NPA on the basis of record of

recovery rather than security charged in favour of the bank in respect of

such account. Thus, an account of a borrower may become NPA if

interest charged to that particular borrower is not realised despite the

17

Estelar

account being fully secured.

Identification of Account as NPA

RBI has laid down various criteria for classification of various types

of advances as NPA which are as under21:

Term Loan : Interest and /or installment of principal remain overdue

for a period of more than 90 days.

One will have to determine the due date of interest and installment.

If either interest or installment is overdue for more than 90 days then the

account would become NPA. Interest or installment, which is due as on

30th December, would be overdue for more than 90 days as on 31st

March 2006 and the account would become NPA. However, if the same

was due on 31st December 2005, then the account would not become

NPA as on 31st March 2006.

Overdraft/Cash Credit : If an account remains out of order, it would

become NPA. For this purpose an account would be treated as ‘out of

order’ if :

(i) The outstanding balance remains continuously in excess of the

sanctioned limit/drawing power for 90 days or more, or

(ii) Even if the outstanding in the account is less than the

sanctioned limit /drawing power, there are no credits in the

account continuously for 90 days as on the date of Balance

sheet, or

(iii) Credits in the account are not sufficient to cover interest

18

Estelar

debited during the same period.

Thus, as on 31st March 2006, if any of the above criteria is

satisfied, the account would be classified as NPA. There may be a

situation where say for example drawing power of an account is Rs.10

lacs, balance is Rs. 8 lacs and there are no credits in the account for 90

days. Such account would be classified as NPA.

Bills Purchased/Discounted : If the bills purchased or discounted

remains overdue for a period of more than 90 days from its due date.

Agricultural Advances : A loan granted for (i) Short duration crops

will be treated as NPA, if the installment of principal or interest thereon

remains overdue for two crop seasons. (ii) Long duration crops will be

treated as NPA, if the installment of principal or interest thereon remains

overdue for one crop season.

For the purpose of these guidelines, “long duration” crops would be

crops with crop season longer than one year and crops, which are not

“long duration” crops would be treated as “short duration” crops.

Thus an auditor will have to verify the nature/duration of crop circle

and accordingly verify whether an agricultural account is NPA as on 31st

March 2006.

Other Credit Facility : In case of any other credit facility, if the

amount to be received remains overdue for more than 90 days, then the

account will be classified as NPA.

Accounts with temporary deficiencies : Even though criteria laid

down for identification of an account as NPA are objective, an account

19

Estelar

should not be classified as NPA, if the deficiencies like non-submission

of stock statement and, non-renewal of facility in the account are

temporary in nature. RBI guidelines in this regard as follows :

Drawing power is required to be arrived at based on the stock

statement, which is current. However, considering the difficulties of large

borrowers, stock statements relied upon by the banks for determining

drawing power should not be older than three months. The outstanding

in the account based on drawing power calculated from stock

statements older than three months, would be deemed as irregular. A

working capital borrower account will become NPA if such irregular

drawings are permitted in the account for a continuous period of 90 days

even though the unit may be working or the borrower’s financial position

is satisfactory.

Thus, if a borrower is allowed drawing on the basis of stock

statement of September ‘05, the account will be classified as NPA as on

31st March 2006.

Regular and ad hoc credit limits need to be reviewed/regularised

not later than three months from the due date/date of ad hoc sanction. In

case of constraints such as non-availability of financial statements and

other data from the borrowers, the branch should furnish evidence to

show that renewal/review of credit limits is already on and would be

completed soon. In any case, delay beyond six months is not

considered desirable as a general discipline. Hence, an account where

the regular/ ad hoc credit limits have not been reviewed/ renewed within

180 days from the due date/date of ad hoc sanction will be treated as

20

Estelar

NPA.

Income Recognition

Income from NPA is not recognised on accrual basis but is booked

as income only when it is actually received. Therefore interest on any

NPA should not be recognized unless realized.

However, interest on advances against term deposits, NSCs, IVPs,

KVPs and Life policies may be taken to income account on the due

date, provided adequate margin is available in the accounts. If

Government guaranteed advances become NPA, the interest on such

advances should not be taken to income account unless the interest has

been realised.

Reversal of Income

(i) If any advance, including bills purchased and discounted,

becomes NPA as at the close of any year, interest accrued and credited

to income account in the corresponding previous year, should be

reversed or provided for if the same is not realized during the year under

audit. This will apply to Government guaranteed accounts also.

(ii) In respect of NPAs, fees, commission and similar income that

have accrued should cease to accrue in the current period and should

be reversed or provided for with respect to past periods, if not collected.

(iii) The finance charge component of finance income [as defined in

‘AS19-Leases’ issued by the Council of the Institute of Chartered

Accountants of India (ICAI)] on the leased asset which has accrued and

was credited to income account before the asset became

21

Estelar

non-performing and remain unrealised, should be reversed or provided

for in the current accounting period.22

Appropriation of Recovery in NPAs

(i) Interest realised on NPAs may be taken to income account

provided the credits in the accounts towards interest are not out of

fresh/additional credit facilities sanctioned to the borrower concerned.

(ii) In the absence of a clear agreement between the bank and the

borrower for the purpose of appropriation of recoveries in NPAs banks

should adopt an accounting principle and exercise the right of

appropriation of recoveries in a uniform and consistent manner. Thus, as

per the consistent policy of the bank recovery may be appropriated

towards interest or principal.

(iii) As per income recognition norms, bank cannot recognise

income unless realised. However, bank can debit interest to NPA

account provided it is credited to interest suspense account.

Asset Classification

Having identified assets as NPA, banks are required to classify

them further into -

a) Sub-standard Assets

b) Doubtful Assets

c) Loss Assets

(i) Sub-standard Assets : A sub-standard asset is one, which has

remained NPA for a period of less than or equal to 12 months.

22

Estelar

(ii) Doubtful Assets : An asset is classified as doubtful if it has

remained in the sub-standard category for a period of 12 months and up

to 36 months.

(iii) Loss Assets : A loss asset is one 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. In other words, such an asset is

considered uncollectible and of such little value that its continuance as a

bankable asset is not warranted although there may be some salvage or

recovery value.

Exceptions : In respect of accounts where there are potential

threats for recovery on account of erosion in the value of security or

non-availability of security and existence of other factors such as frauds

committed by borrowers, it will not be prudent that such accounts should

go through various stages of asset classification. In cases of such

serious credit impairment the asset should be straight away classified as

doubtful or loss asset as appropriate.

(i) Erosion in the value of security can be reckoned as significant

when the realisable value of the security is less than 50 per cent of the

value assessed by the bank or accepted by RBI at the time of last

inspection, as the case may be. Such NPAs may be straight away

classified under doubtful category and provisioning should be made as

applicable to doubtful assets.

(ii) If the realisable value of the security, as assessed by the

bank/approved valuers/RBI is less than 10 per cent of the out-standing

23

Estelar

in the borrower accounts, the existence of security should be ignored

and the asset should be straight away classified as loss asset. It may be

either written off or fully provided for by the bank.23

1.5 Appraisal of Managerial Capability of a Borrower : A

Key Element in Credit Decisions

Credit processing is the stage where all required information on

credit is gathered and applications are screened. Credit application

forms should be sufficiently detailed to permit gathering of all information

needed for credit assessment at the outset. In this connection, financial

institutions should have a check list to ensure that all required

information is, in fact, collected.

Financial institutions should set out pre-qualification screening

criteria, which would act as a guide for their officers to determine the

types of credit that are acceptable. For instance, the criteria may include

rejecting applications from blacklisted customers. These criteria would

help institutions avoid processing and screening applications that would

be later rejected.

Moreover, all credits should be for legitimate purposes and

adequate processes should be established to ensure that financial

institutions are not used for fraudulent activities or activities that are

prohibited by law or are of such nature that if permitted would

contravene the provisions of law. Institutions must not expose

themselves to reputational risk associated with granting credit to

customers of questionable repute and integrity.

24

Estelar

The next stage to credit screening is credit appraisal where the

financial institution assesses the customer’s ability to meet his

obligations. Institutions should establish well designed credit appraisal

criteria to ensure that facilities are granted only to credit worthy

customers who can make repayments from reasonably determinable

sources of cash flow on a timely basis.

Financial institutions usually require collateral or guarantees in

support of a credit in order to mitigate risk. It must be recognized that

collateral and guarantees are merely instruments of risk mitigation. They

are, by no means, substitutes for a customer’s ability to generate

sufficient cash flows to honour his contractual repayment obligations.

Collateral and guarantees cannot obviate or minimize the need for a

comprehensive assessment of the customers ability to observe

repayment schedule nor should they be allowed to compensate for

insufficient information from the customer.

Care should be taken that working capital financing is not based

entirely on the existence of collateral or guarantees. Such financing

must be supported by a proper analysis of projected levels of sales and

cost of sales, prudential working capital ratio, past experience of working

capital financing, and contributions to such capital by the borrower

itself.24

In conclusion, it can be said that appraisal of managerial capability

of a borrower is a key element in credit sanctioning decision and if the

managerial capability has been appraised accurately and credit decision

25

Estelar

taken according to it then the chance of this credit to become a

non-performing asset will be negligible and vice versa.

1.6 About the Present Study

Research methodology discusses the following aspects of

research:

1.6.1 Problem to be Investigated

Public sector banks are important constituent of Indian financial

system. They play a crucial role in the attainment of macro-economic

objectives. These banks act as a vehicle for socio-economic

transformation and also act as a catalyst for economic growth. On one

hand, they help in mobilising the nation’s savings and on the other, they

channelize these savings into higher investment priorities.

Public sector banks have made a significant progress after

nationalisation in three aspects: Branch expansion, deposit mobilisation

and loan maximisation. Among these, monitoring of loans took a back

seat in an era of mass banking and social banking. In the changing

scenario of the operations, Non-Performing Assets (NPAs) have been

the most vexing problem faced by public sector banks. The Reserve

Bank of India and Government of India has made various measures to

curb NPAs in the post-financial sector reforms. The research will details

the trends in NPAs, sectoral composition of NPAs, asset quality

diagnosis and the scenario of NPA at the bank level. This study reveals

that the gross and net NPAs of public sector banks have gone down

26

Estelar

gradually due to their strong commitment towards reduction and

management of NPAs.

1.6.2 Significance of the Study

In the post nationalization period, public sector banks in India have

made rapid strides of progress but due to competition, organisation

constraints, fluctuations in the market and inflationary trends weakening

operational efficiency has been noticed in some of the cases which is

rectified by the banks in current scenario to some extent. In this context,

an attempt has been made to examine:

· the productivity and profitability of public sector banks in India

· the management of Non Performing Assets by the banks under

study.

· the impact of effective management of Non Performing Assets

on public sector banks.

· Social objectives fulfilled by public sector banks.

The study will be immense importance to the researchers,

students, policy makers, academicians, bankers, financial analysts and

the common masses.

1.6.3 Objectives of the Study

The objectives help in focusing the study on the result that is

desired to be achieved by the research. The main objectives of the

study are as follows:

27

Estelar

1. To study the geometrically increasing growth of non performing

assets in selected public sector banks.

2. To study the causes of origin of NPAs.

3. To review the present position of NPAs.

4. To make comparative analysis between public sector banks

about prevalence of NPAs.

5. To suggest remedies and strategies for controlling NPAs.

6. To find out the techniques of solving problems of NPAs

according to prudential norms of RBI and other committees.

1.6.4 Hypothesis

A hypothesis state what we are looking for and it is a proposition

which can be put to test and determine its validity. The hypothesis may

not be proved absolutely, but in practice it is accepted if it has withstood

a critical testing otherwise rejected.

(a) Central Hypothesis : The selection of the topic has been made

with a view to evaluating, analyse and examine the non performing

assets of the public sector banks under study. It is true that these banks

are performing well and in profitable condition but a significant

percentage of their assets are becoming non performing assets and

amount of these non performing assets is not decreasing with time.

Hence there is a need to control them adequately. The present study is

based on the hypothesis that the management performance of

non-performing assets is very poor in public sector banks in India as

anticipated by Reserve Bank of India and other committees. It needs

28

Estelar

adequate improvement.

(b) Sub Hypothesis :

(i) The NPA is increasing continuously in public sector banks.

(ii) Liberalization is one of the factors to increase non performing

assets in banks.

(iii) The selected public sector banks have not successfully

managed their non performing assets.

(iv) The NPAs recovery performance of banks is not satisfactory.

1.6.5 Period of the Study

The present study has been covered a period of five years from

2007-08 to 2011-12.

1.6.6 Units of the Study

For the purpose of study, following three banks have been

selected:

1. Bank of Baroda

2. Canara Bank

3. UCO Bank

1.6.7 Plan of Research Design

Research design is the overall framework of the research project

which mentions about the types of sources of information and

29

Estelar

procedures to be followed in collecting it. It is simply the specifications of

methods and procedures for acquiring information needed. The

research design includes the methods of research likewise survey,

observation, experiment, the content analysis and their combinations. It

also include the type of data (quantitative and qualitative) to be

collected, structured or unstructured schedules and also about the size

and techniques of sampling.

Data Collection : The present study is based on secondary data

which have been obtained through annual reports of selected banks,

annual bulletins of Reserve Bank of India, trend and progress report of

banking in India, statistical report related to banking in India, journals,

magazines, newspapers and other published material available.

Data Analysis : For analysing the data, accounting techniques like

ratio analysis, percentage trend and graphical representation have been

used. On the basis of these parametric tests, the conclusions have been

interpreted and submitted in a report form.

1.6.8 Review of Literature

The researcher gone through the available literature about the

non-performing assets in Indian Pubic Sector Banks. Various reports

and bulletins of Reserve Bank of India, thesis work, periodicals,

research articles etc. have been studied. A brief description of this

review of literature is as follows:

By the year 2001, the view was crystallized that a bulk segment of

30

Estelar

NPA consists of credit availed by big corporates, who are willful

defaulters. This section of borrowers is able to prolong and continue to

default repayment taking advantages of the deficiencies in the Legal

framework. These views are conveyed in RBI Report of Banking for the

year 2001 published on 15th November 2001.

According to this R.B.I. report, non-performing assets have been

substantially reduced since regulation was tightened in 1993, but

improvement has recently showed down and the levels of NPAs remain

high compared to international standards. In 2001, the commercial

banking system’s gross NPA to gross advances ratio was 11.4 per cent;

net of provisions, it was 6.2 per cent. The public sector banks’ NPA

witnessed a decline in 2001, with the gross NPA to gross advances ratio

being 12.4 per cent, and 7.4 per cent, respectively.

Asset Reconstruction and Securitisation : The suggestion of

creation of Asset Reconstruction company to tackle problem of

hangover piled up past NPAs was first suggested by Narasimham

Committee Report II. To Quote therefrom - “An important aspect of the

continuing reform process is thus to reduce further the high level of

NPAs as a means of institutional strengthening. While there is reason to

expect that with a combination of policy and institutional development,

new NPAs could in future be lower than hitherto, the problem remains of

the huge backlog of existing. NPAs which impinges severely on banks

performance and their profitability. Several approaches are possible.

The earlier Committee had suggested the creation of an Assets

Reconstruction Fund (ARF) to take these assets off banks books at a

31

Estelar

discount. Recapitalization through infusion of capital is another

approach and has been used in the case of some banks. In the last six

years massive budgetary funds have been used for recapitalization of

public sector banks. This a costly and over time, not a sustainable

option. The problem however remains and consideration would need to

be given to revisiting the concept for an ARF.” The Ordinance for

creation of ARCs for recovery of NPAs of Banks was passed during

June 2002 and this was upgraded as an Act of the Parliament in

December 2002. This is an important measure, as handicaps posed by

the infirmities of the legal system were undergone.

Deergha Sharma (2009) in her Ph.D. thesis “Working of Public

Sector Banks in India with Special Reference to Non Performing Assets

in Selected Banks (2000-2008)” submitted to University of Rajasthan,

Jaipur in which she took four banks namely State Bank of India, Bank of

Baroda, Central Bank of India and Punjab National Bank. The work was

focused on working of public sector banks. It was divided into seven

chapters as: (i) Introduction, (ii) Organisation of Public Sector Banks, (iii)

Working of Public Sector Banks, (iv) Productivity and Profitability of

Public Sector Banks, (v) Human Resource Management in Public Sector

Banks, (vi) Management of Non Performing Assets by selected Public

Sector Banks and (vii) Summary of findings and Suggestions. There is

only one chapter (Chapter sixth) discusses about non performing

assets. She concluded that the selected banks have decreased their

gross and net NPA as percentage of total assets by strong recoveries to

avoid the slippage of accounts in NPA.

32

Estelar

Meenakshi Rajeev and H.P. Mahesh (2010) in their research paper

“Banking Sector Reforms and NPA: A Study of Indian Commercial

Banks” concluded that the issue of non-performing assets (NPA), the

root cause of the recent global financial crisis, has been drawing the

attention of the policy makers and academicians alike. The problem of

NPAs, which was ignored till recently, has been given considerable

attention after liberalisation of the financial sector in India. This

exploratory paper examines the trends of NPAs in India from various

dimensions and explains how mere recognition of the problem and

self-monitoring has been able to reduce it to a great extent. It also

shows that public sector banks in India, which function to some extent

with welfare motives, have as good a record in reducing NPAs as their

counterparts in the private sector. The paper also discusses the role of

joint liability groups (JLGs) or self help groups (SHGs) in enhancing the

loan recovery rate.

Siraj K.K. and Prof. (Dr.) P. Sudarsanan Pillai, “A Study on the

Performance of Non-Performing Assets (NPAs) of Indian Banking during

Post Millennium Period”, International Journal of Business and

Management Tomorrow, Vol.2, No.3, March 2012.

According to this research paper, NPA is a virus affecting banking

sector. It affects liquidity and profitability, in addition posing threat on

quality of asset and survival of banks. This study explored movement of

various NPA indicators; Gross NPA, Net NPA, Additions to NPA,

Reductions to NPA and Provisions towards NPA and compare it with

Total Advances and Total Deposits of banks. The study utilized

33

Estelar

bank-group wise performance statistics for post-millennium period up to

the period ended 31st December 2011. The study utilized growth rate

calculating using AAG rate, correlation and regression study to analyze

the movement and significance of NPA indicators during the period. The

effect global financial crisis on the NPA indicators as well is explained.

The study concluded that NPA still remains a major threat and the

incremental component explained through additions to NPA poses a

great question mark on efficiency of credit risk management of banks in

India.

Prashanth K. Reddy, “A comparative study of Non Performing

Assets in India in the Global context - similarities and dissimilarities,

remedial measures”, IIM Ahmedabad, October, 2002.

In this paper, the author opined that financial sector reform in India

has progressed rapidly on aspects like interest rate deregulation,

reduction in reserve requirements, barriers to entry, prudential norms

and risk-based supervision. But progress on the structural-institutional

aspects has been much slower and is a cause for concern. The

sheltering of weak institutions while liberalizing operational rules of the

game is making implementation of operational changes difficult and

ineffective. Changes required to tackle the NPA problem would have to

span the entire gamut of judiciary, polity and the bureaucracy to be truly

effective. This paper deals with the experiences of other Asian countries

in handling of NPAs. It further looks into the effect of the reforms on the

level of NPAs and suggests mechanisms to handle the problem by

drawing on experiences from other countries.

34

Estelar

Pacha Malyadri and S. Sirisha, “A Comparative Study of Non

Performing Assets in Indian Banking Industry”, International Journal of

Economic Practices and Theories, Vol.1, No.2, October, 2011.

The Indian banking system has undergone significant

transformation following financial sector reforms. It is adopting

international best practices with a vision to strengthen the banking

sector. Several prudential and provisioning norms have been introduced,

and these are pressurizing banks to improve efficiency and trim down

NPAs to improve the financial health in the banking system. In the

background of these developments, this study strives to examine the

state of affair of the Non Performing Assets (NPAs) of the public sector

banks and private sector banks in India with special reference to weaker

sections. The study is based on the secondary data retrieved from

Report on Trend and Progress of Banking in India. The scope of the

study is limited to the analysis of NPAs of the public sector banks and

private sector banks NPAs pertaining to only weaker sections for the

period seven years i.e. from 2004-2010. It examines trend of NPAs in

weaker sections in both public sector and private sector banks. The data

has been analyzed by statistical tools such as percentages and

Compound Annual Growth Rate (CAGR). The study observed that the

public sector banks have achieved a greater penetration compared to

the private sector banks vis-à-vis the weaker sections.

Poongavanam. S., “Non performing assets: Issues, Causes and

remedial Solution”, Asian Journal of Management Research, Volume 2

Issue 1, 2011, pp.123-132.

35

Estelar

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 very cautious in extending

loans, this is due to mounting non-performing assets (NPAs). Therefore,

an NPA account not only reduces profitability of banks by provisioning in

the profit and loss account, but their carrying cost is also increased

which results in excess and avoidable management attention. Apart

from this, a high level of NPA also puts strain on a bank’s net worth

because banks are under pressure to maintain a desired level of Capital

Adequacy and in the absence of comfortable profit level, banks

eventually look towards their internal financial strength to fulfill the

norms thereby slowly eroding the net worth. Considering all the above

facts banking industry has to give more importance to NPA and to

structure proper remedial solutions.

1.6.9 Scope of the Study

Although this study has been covered only three Indian banks but

the management of non-performing assets is a universal problem and

almost every bank and finance provider institution suffering from it.

Hence, this study has a wide scope not only useful for selected banks

but also other banks and finance providing institutions in India and

36

Estelar

abroad, their managements, governments, employees and

shareholders.

1.6.10 Limitations of the Study

Although maximum efforts have been made for an extensive study

of the management of non-performing assets in selected banks but it is

true that a researcher has to function under various constraints and

limitations. Since the researcher has to depend heavily upon published

reports, literature and secondary data, one of the limitations lies in the

quality of the accounting data. Further, the techniques and tools of

investigations have also inherent limitations, e.g. financial data are the

mixture of convenience and convention. The cooperation in collection of

primary data and information about the working style of key persons

affecting management of non-performing assets, by the bank official was

negligible. Lastly, the study is a subject to general human limitations.

37

Estelar

Reference

1. Reserve Bank of India, Report on trend and Progress of Banking in

India, 2004-2005 to 2010-2011.

2. Reserve Bank of India, “Master Circular - Prudential Norms on income

Recognition, Asset Classification and Provisioning pertaining to

Advances”, DBOD.No.BP.BC.21 /21.04.048/ 2010-11 on dated July 1,

2010.

3. GOI (1999), Report on Non-performing Assets of Public Sector Banks,

Ministry of Finance, New Delhi.

4. Rajaraman I., Bhaumik S. and Bhatia N., “NPAs Variations across

Indian Commercial Banks”, Economic and Political Weekly, Jan.16-23,

1999, pp.161-168.

5. Ibid.

6. Shajahan K.M., “Non-performing Assets of Banks- Have they Really

Declined and on Whose Accounts”, Economic and Political Weekly,

Vol.33, 1998, pp. 671-674.

7. Rajaraman I., Bhaumik S. and Bhatia N., op.cit., p.164.

8. Shajahan K.M., op.cit., p.673.

9. Ibid.

10. Rajaraman I., Bhaumik S. and Bhatia N., op.cit., p.165.

11. Ibid.

12. Rajaraman I., Garima V., “Non-performing Loans of PSU Banks- Some

Panel Results”, Economic and Political Weekly, Vol.27, 2002,

pp.429-435.

13. Ibid.

14. The Securitisation Companies and Reconstruction Companies

(Reserve Bank) Guidelines and Directions, 2003, RBI/2009-2010/12,

DNBS (PD) CC. No. 15/SCRC/ 26.03.001/ 2009-2010.

38

Estelar

15. Ibid.

16. Rajaraman I., Garima V., op.cit., p.430.

17. The Securitisation Companies and Reconstruction Companies

(Reserve Bank) Guidelines and Directions, 2003, RBI/2009-2010.

18. Ibid.

19. RBI (1991), The Committee of Financial Sector Reforms, RBI, Bombay.

20. RBI (1991), The Committee of Financial Sector Reforms, RBI, Bombay.

21. RBI (1999), “Some Aspects and Issues Relating to NPAs in Commercial

Banks”, RBI Bulletin, Vol. LIII, No. 7, pp. 913-936.

22. Ibid.

23. RBI (1999), “Some Aspects and Issues Relating to NPAs in Commercial

Banks”, RBI Bulletin, Vol. LIII, No. 7, pp. 913-936.

24. Das Abhiman, “Risk and Productivity Change of Public Sector Banks”,

Economic and Political Weekly, 37(5), 2002, 437-48.

*****

39

Estelar