non performing assets jims

8/8/2019 Non Performing Assets Jims

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Non Performing Assets:

An asset, including a leased asset, becomes non-performing when it ceases to generate income

for the bank. A non-performing asset is a loan or advance where:

y Interest and / or installment of principal remain overdue for a period of more than 90 daysy The account remains out of order in respect of an Overdraft/Cash/Cash Credit

(OD/OC).

y The bill remains overdue for a period of more than 90 days in the case of bills purchasedand discounted.

y A loan granted for short duration crops will be treated as NPA, if the installment ofprincipal or interest thereon remains overdue for two crop seasons.

y A loan granted for long duration crops will be treated as NPA, if the installment ofprincipal or interest thereon remains overdue for one crop season.

y Banks should classify an account as BNPA only if the interest charged during any quarteris not serviced fully within 90 days from the end of the quarter.

Net NPA as percentage of net advances

Net Non Performing Assets (NPAs) are gross NPAs net of provisions on NPAs and suspense

account. Net NPA is obtained by deducting items like interest due but not recovered, part

payment received and kept in suspense account etc., from Gross NPA.

Asset Classification:

Banks are required to classify non-performing assets further into following three categories

based on the period for which the asset has remained non-performing and the reliability of the

dues.

y Sub-standard Assets: With effect from 31.03.2005, a sub-standard asset would be onewhich has remained NPA for a period less than or equal to 12 months.


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y Doubtful Assets: With effect from 31.03.2005, a doubtful asset would be one which hasremained in the sub-standard category for a period of 12 months.

y Loss assets: A loss asset is one where loss has been identified by the bank or internal orexternal auditors or the RBI inspection but the amount has not been written off wholly.

The classification of assets and provisioning norms as per the extant guidelines and as detailed

above could be summarized as depicted in the following table.

Classification of Assets Description Provisioning Norms

Standard Assets Otherwise known as

performing assets

0.40% on standard assets

0.25% on direct advances to

agriculture and SME 1.00%

on personal loans, capital

market exposures, residential

houses beyond Rs. 20 lacs

and commercial real estate

Sub-standard Assets NPAs up to a period of 2

years

10 % on total outstanding

irrespective of security

coverage/ guarantee. The

unsecured portion will attract

additional provision of 10

percent.

Doubtful Assets NPAs over two years 100 % shortfall in the

securities and 20%/ 30%

60%/ 100% depending upon

the age of the asset

Loss Assets NPAs in which there waslittle/ negligible realizable

value of security

100% of balance outstanding

Reasons for NPAs in Banks


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An account does not become an NPA overnight. It gives signals sufficiently in advance that steps

can be taken to prevent the slippage of the account into NPA category. An account becomes an

NPA due to causes attributable to the borrower, the lender and for reasons beyond the control of

both.

Attributable to the Borrower / Project

The following is a list of factors attributable to the borrower, which could account for the

borrower's accounts becoming non-performing assets:

y Financial losses for two years consecutively.y Poor management and marketing strategy, poor assessment of demand, over capacity for

the product, lack of commitment, entering a declining market, price war, etc.

y Diversion of funds within and outside the business or project. Sometimes funds arediverted for another project.

y Differences and disputes among promoters/directors.y The bandwagon effect. People with little experience in the field enter a profession just

because others have succeeded recently. This is common in the construction, real estate

and hospitality industries.

y High cost base evidenced by labor costs, low productivity, distribution costs, rawmaterial cost, high reorganization cost.

y Inadequate financial control demonstrated by poor debt management/structure.y Inadequate information which is demonstrated by the following - poorly prepared

budgets or no budgets, no costing/unit costs, limited analysis/planning for stocks, capital

expenditure not planned/budgeted.

y Time and cost overrun due to poor supervision and control over the project by thepromoters.

y Increasing low margin sales, debtor provisions, currency losses, creditor pressure, andshort-term debt. Emphasis on cash sales with little regard for profit.

y Borrowing to pay operational expenses like electricity, wages, etc.y Recurrence of problems previously resolved.y Maintenance of expensive offices/keeping premises in a continuous state of neglect.


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y Short term loans / ad hoc loans/excess over limits continuing beyond due date.y Qualified audit opinion.y Unable to comply with loan covenants.y Liquidity ratios reveal deteriorating trends.y Increase in creditors days outstanding.y Speculative investmentsy However, there are also external factors over which the borrower has no control and these

could also lead to non-performing assets. These external factors could include:

y Delay in financial closure.y Delay in realization of receivables.y Exchange rate fluctuations.y Depressed capital market.y General recession in the particular industry.y Changes in personal habits of promoters/key people.

Fraud is also a contributory factor to cases of NPAs. The following are all signs of fraud that

need to be recognized in order to prevent NPAs.

y Sales/inventory/assets overstated, liabilities understated.y Audits cease.y Abnormally large fund transfers.y Significant cash balances in non-interest earning accounts.y Management overrides internal controls.y Sale of assets to related parties.y Unusual supplier relationships.y Staff working unusually long working hours.

Attributable to the Bank

y Deficiency in credit assessment and monitoring system.y Improper valuation of securities at the time of appraisal of loans.


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y Failure in verification of end use of the loans and improper follow-up of and inadequateperiodical verifications.

y Inadequacy/ deficiency insecurity creation/ documentation at the time of disbursal ofloans.

y Laxity in taking timely corrective measures when an asset emits distress signals.y Delay in decision making regarding rendering of further assistance.y Excess/short lending.y Non-adoption of appropriate resolution strategy for tackling of NPA accounts.y Managerial deficiencies or incompetence of the borrowers.y Delay in implementation of the projects leading to cost escalation.y Diversification/siphoning of funds.y Willful default of the borrower.

External / Others

y Lack of demand for the product in market and downward trend in sales.y Increase in rate of interest.y Delay in implementation of rehabilitation programme.y Borrower friendly legal environment for recovery of defaulted loans.y Change in the overall economic environment of the country.

Steps needed to reduce NPA

y Arresting slippage of accounts through relentless monitoring and focus on the continuousviability of the borrowing concern with improved asset classification is must. At the same

time all accounts in the Standard category should not be taken for granted and should be

subjected to periodical and in-depth review in a systematic manner through a sound

adequate loan review mechanism in place.

y Categorization of standard accounts into A, B, C based on actual recovery of interest andinstallments due, will help a focused and strengthened monitoring.

y Banks should ensure that they should move with speed and charged with momentum indisposing off the loss assets. This is because as uncertainty increases with the passage of


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time, there is all possibility that the recoverable value of asset also reduces and it cannot

fetch good price. If faced with such a situation than the very purpose of getting protection

under the Securitization Act, 2002 would be defeated and the hope of seeing a must have

growing banking sector can easily vanish.

y Bank should adhere to Know Your Customer norms for identification of borrower,guarantor and verification of their addresses to minimize the risk of default in case of

housing sector lending. In respect of agricultural advances, recovery camp should be

organized during the harvest season.

y Ongoing monitoring of banks borrowers is important to understand the primary cause ofcorporate decline and to be able to identify the symptoms of a potential distress situation.

Loan Officers and staff should be alert and diligent for signs of borrower distress. It is

essential to identify signs of distress which diminish the Borrowers capacity to repay

debt. Early recognition followed by appropriate action is essential if the bank is to

minimize NPAs.

y Loan Workout Unit should be created which should be exclusively responsible formanaging non-performing and under performing loans to maximize the recovery value

from a portfolio of distressed loans, through the employment of an equitable and

professional workout process.

Doubtful AssetsExample

Existing stock of advances classified as doubtful more than 3 years as on March 2004

The outstanding amount as on 31 march 2004 Rs. 25,000

Realizable value of security: Rs 20,000

Period for which the advance has remained in doubtful category as on 31 March 2004:

4years (i;e doubtful more than 3 years)

Provisioning requirement:

As on --- Provisions on Secured

portion% Amount

Provisions on Secured

portion% Amount

Total (Rs)

31 March

2004

50 10,000 100 5,000 15,000

31 March 60 12,000 100 5,000 17,000


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2005

31 March

2006

75 15,000 100 5,000 20,000

31 March

2007

100 20,000 100 5,000 25,000

Sub Standard Assets

A general provision of 10% on total outstanding to be made (without making any allowance for

ECGC guarantee cover and securities available) . The unsecured exposures identified as sub

standard would attract additional provision of 10 percent thus constituting 20 % on the

outstanding balance.

Unsecured exposure is defined as an exposure where the realizable value of the security, as

assessed by the bank/approved valuers/ Reserve Banks inspecting officers, is not more than 10

percent of the outstanding advances. Exposure should include all funded and non funded

exposures (including underwriting and similar commitments). Security will mean tangible

security properly discharged to the bank and will not include intangible securities like

guarantees, and comfort letters.

Provisions where ECGC Guarantee is available

In the case of advances classified as doubtful and guaranteed by ECGC, provision should be

made only for the balance in excess of the amount guaranteed by the corporation. While arrivingat the provision required to be made for doubtful assets, realizable value of the securities should

be declared from the outstanding balance in respect of the amount guaranteed by the corporation

before provisioning.

Example: Hypothetical Case

Outstanding balance Rs.4 lakh

ECGC cover 50 percent

Period for which advance has remained

doubtful

More than 3 years remained doubtful(as on 31

March 2004)

Value of security held Rs. 1.50 Lakh


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Provisions required to be made

Outstanding balance Rs. 4 Lakh

Less: Value of security held Rs. 1.50 Lakh

Unrealised balance Rs. 2.50 Lakh

Less: ECGC Cover (50% of unrealizable

balance)

Rs. 1.25 Lakh

Net Unsecured portion of advance Rs. 1.25 Lakh

Provision for secured portion of advance Rs. 1.25 Lakh (@ 100% of unsecured portion)

Provision for secured portion of advance (as on

31 March 2005)

Rs. 0.90 Lakh (@ 60 % of the secured portion)

Total Provisions to be made Rs. 2.15 Lakh (as on March 2005)

Format for reporting NPAs to RBI

Reporting Format for NPA-Gross and Net Position

Name of the Bank:

Position as on -------------------------

(Rupees in crore up to two decimals)

Particulars Amount

1. Gross advances2. Gross NPA3. Gross NPA as % of gross advances4.

Total Deductions(1+2+3+4)

a. Balance in interest suspense accountb. DICGC/ECGC claims received and held pending adjustmentc. Part payment received and kept in suspense accountd. Total Provisions held


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5. Net Advances (1-4)6. Net NPA (2-4)7. Net NPA as % of Net Advances

Gross advances mean all outstanding loans and advances including advances for which refinance

has been received but excluding rediscounted bills, and advances written off at head office level

(technical write- off).

Note: Provisions made for NPA are not eligible for tax deduction but tax benefits can be enjoyed

by the bank for claiming write-off advances.

Writing off NPAs

Example explains the impact of provisioning and write-off on banks profits

Profit before provisioning forBank A is Rs. 500 crore. If the tax rate is 30 percent , what will bethe impact of the following actions on Bank As a. Profits and b. capital base.

Make a provision of Rs. 250 crore for NPAs

Options:

Provide Rs. 200 crore for NPAs and

Write off the remaining Rs. 50 crore

Option 1: Provide for Rs. 250 crore for NPAs

Profit before provision Rs. 500 crore

Less provision for NPAs Rs. 250 crore

Profit before Tax Rs. 250 crore

Less Tax at 30% Rs. 150 crore (since provision for NPAs not tax deductible, tax

calculated at 30% of Rs. 500 crore)

Profit AfterTax Rs.100 crore

Option 2: Provide for Rs. 200 crore for NPAs and write -off Rs. 50 crore

Profit before provision Rs. 500 crore


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Less provision for NPAs Rs. 200 crore

Less Write-off Rs. 50 crore

Profit before Tax Rs. 250 crore

Less Tax at 30% Rs. 135 crore (since write-off for NPAs are tax deductible, tax

calculated on profit before tax + provisions = Rs. 450 crore)

Profit AfterTax Rs.115 crore

Interpretation:

Option 2 yields more profits after tax and hence would augment the capital base more than

Option 1.

non performing assets jims

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