NPA SYSTEM & FINANCIAL INSTITUTION IN INDIA

NPA IN BANKING SYSTEM & FINANCIAL INSTITUTION IN INDIA

The origin of the problem of burgeoning NPA’s lies in the quality of managing credit risk by the banks concerned. What is needed is having adequate preventive measures in place namely, fixing pre-sanctioning appraisal responsibility and having effective post disbursement supervision. Banks concerned. Should continuously monitor loans to identify accounts that have potential to become non-performing.

To start with, performance in terms of profitability is a benchmark for any business enterprise including the banking industry. However, increasing NPA’s have a direct impact on banks profitability as legally banks are not allowed to book income on such accounts and at the same time banks are forced to make provision on such assets as per the Reserve bank of India (RBI) guidelines. Also with increasing deposits made by the public in the banking system. The banking industry cannot afford defaults by borrower a since NPA’s affects the repayment of banks. Further, Reserve Bank of India (RBI) successfully creates excess liquidity in the system through various rate cuts and banks fail to utilize thus benefit to its advantage due to the fear of burgeoning non-performing assets.

RBI GUIDELINES ON INCOME RECOGNITION (interest income on NPA’s)

Banks recognize income including interest income on advances on accrual bases. That is, income is accounted for as and when it is earned. The prima-facie condition; for accrual of income is that it should not be unreasonable to expect its ultimate collection .However, NPA’s. Involves significant uncertainty with respect of its ultimate collection. Considering this fact, in accordance with the guidelines for income recognition issued by Reserve Bank if India (RBI) banks should not recognize interest income on such NPA’s actually realized.

ACCOUNTING STANDARD (AS-9) 0N REVENUE RECOGNITION ISSUED BY ICAI

The Accounting Standard 9(AS-9) on ‘Revenue Recognition’ issued by the Institute of Charted Accountants of India (ICAI) requires that the revenue that arises from the uses by other of enterprise resources yielding interest yielding interest should be recognized only when there is non significant only when there is no significant uncertainty as to its measurability or collect ability. Also, interest income should be recognized on a time proportion basis after taking into consideration rate applicable and the total amount outstanding.

RBI GUIDELINES ON NPA’S AND ICAI ACCOUNTING STANDARD ON REVENUE RECOGNITION

In view of the guidelines issued by the Reserve Bank o India (RBI) interest income on NPA’s should be recognized only when its is actually realized. As such, a doubt may arise as to whether the aforesaid guidelines with respect to recognition of interest income on NPA’s on realization basis is consistent with Accounting Standard 9, ‘revenue Recognition’. For this purpose, the guidelines issued by the RBI for treating certain assets as NPA’s seem to be based on an assumption that the collection on such assets is uncertain. Therefore complying with AS9, interest income is not recognized based on uncertainty involved but is recognized at a subsequent stage when actually realized there by complying with RBI guidelines as will. In order to ensure proper appreciation of financial statements, banks should disclose the accounting policies adopted in respect of determination of NPA’s and basis on which income is recognized with other significant accounting policies.

HIGH COST OF FUNDS DUE TO NON-PERFORMING ASSETS

Therefore, quite often corporate prefer to raise funds through Commercial Papers (CPs) where the enactment of the Securitization and Reconstruction of Financial Assets and Enforcement of Security interest Act 2002, banks can issue notices to the defaulter to pay the dues and the borrowers will have to clear their dues within 60 days. Once the borrower receives a notice from the concerned bank and the financial institution, the secured assets mentioned in the notice cannot be sold or transferred without the consent of the lenders. The purpose of this notice is to inform the borrower that either the sum due to the bank or financial institution is paid by the borrower or else the former will take action by of taking over the possession of assets

Besides assets, banks can also takeover the management of the company. Thus the bankers under the aforementioned Act will have the much need authority to either sell the assets of the defaulting companies or change their management. But the protection under the said Act only provides a partial solution. What banks should ensure is that they should move with speed and charged with momentum in disposing off the assets. This because as uncertainty increase with the passage of time, there is all possibility that recoverable value of assets also reduces and it cannot fetch good price. If faced with such a situation then 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.

SPECIAL PROBLEMS OF NON-PERFORMING ASSETS IN INDIA

The most critical condition for bring about an improvement in the profitability of banks is a reduction in the level of NPAs had declined significantly in recent years, it is still considered relatively high by international standards. There are, of course, varying country practice for provisioning and therefore, of carrying NPAs on their banks even after making provisions. Moreover, in India, provisioning is relatively more stringent; for instance, provisions are required to be made even on the secured portion; of advances. In other countries identified losses are written off at an early stage and banks carry very little NPAs on there books. Even so, the provision adjusted level of NPA at 8.15 of net advances of public sector banks (PSBs0 in India is high. The distribution of NPAs across the public sector banks shows that there is some rigidity to move down in the category of banks with net NPAs between 10 and 20 percent of net advances as also in the category of banks with net NPAs of up to %of net advances. In these categories, there has not been any significant improvement since 1995-96 the Narasimhan Committee has underscored the need for moving to zero net NPA levels for our banks which have an international presence. If believe in actualizing our resolve to build a banking system with an international orientation, this must be our priority target in the next two to three years.

Out studies on NPA’s in the banking system suggest that the problems of NPA’s has a sizeable overhang component arising from infirmities in the existing process of debt recovery, inadequate legal provisions on foreclosure and bankruptcy, and difficulties in the execution of court decrees. Banks in India face external constraints such as the dominance of traditional industries in credit portfolios, industrial sickness and labour problems. The studies also reveal that there are several internal factors such as weak credit appraisal, non-compliance to lending norms, and willful default that contribute to high NPAs this call for immediate corrective steps in recovery process so that the problem is contained.

What are strategies for making this possible? First, at the policy level, the problems of NPAs should be addressed by strict enforcement of prudential norms and requirements of transparency. Secondly, the most important policy contribution in this area is the need for legislation which will make recovery processes smoother and legal action quicker. Thirdly, banks are being provided with a menu of alternatives such as Debt Recovery Tribunals, Lock Adalats and Asset Reconstruction Companies. The Reserve Bank has provided indicative guidelines for compromise settlement of chronic NPAs in the small scale sector. Settlement Advisor Committees have also been formed at regional and head office levels. These alternatives will not doubt require the enabling environment to be created by appropriate legal reforms which are being addressed jointly by the Reserve Bank and Government of India.

As regards internal factors leading to NPA’s, the onus rests with the banks themselves. This calls for organizational restructuring, improvement in managerial efficiency, skill up-gradation for proper assessment of creditworthiness and change in the attitude of the banks towards legal action which is traditionally viewed as a measure of the last resort. These are the element on the agenda of the second phase of reforms.

Capital Adequacy:

NPA doesn’t earn any income, it adversely affects the capital adequacy ratio, and the adequacy ratio reveals the health condition of the bank. The capital adequacy ratio is defined as the ratio between a bank’s total capital and its risk-weighted assets.

GENERAL REASONS FOR ASSETS BECOMING NPAs

A multiplicity of factor is responsible forever increasing size of NPAs in banks. A few prominent reasons for assets becoming NPAs are as under.

· Poor credit appraisal system

· Lack of proper monitoring

· Reckless in advances to achieve the budgetary targets.

· There is no or lack of corporate culture in the Bank. In adequate legal provisions on foreclosure and bankruptcy.

· Change in economic policies/ environment.

· No transparent accounting policy and poor auditing practices.

· Lack of coordination between banks.

· Directed lending to certain sectors.

· Failure on the part of the promoters to bring their portion of equity from their own source or public issue due to market turning lukewarm.

There are several reasons for an account becoming NPA.

Internal factors

External factors

Internal factors:

Funds borrowed for a particular purpose but not use for the said purpose.

Project not completed in time.

Poor recovery of receivables.

Excess capacities created on non-economic costs.

In-ability of the corporate to raise capital through the issue of equity or other debt

instrument from capital markets.

Business failures.

Diversion of funds for expansion\modernization\setting up new projects helping

or promoting sister concerns.

Willful defaults, siphoning of funds, fraud, disputes, management disputes, miss-

appropriation etc.,

Deficiencies on the part of the banks viz. in credit appraisal, monitoring and

follow-ups, delay in settlement of payments\ subsidiaries by Government bodies

etc.

External factors:

Sluggish legal system - Long legal tangles changes that had taken place in labor

laws Lack of sincere effort.

Scarcity of raw material, power and other resources.

Industrial recession.

Shortage of raw material, raw material\input price escalation, power shortage,

industrial recession, excess capacity, natural calamities like floods, accidents.

Failures, non payment\ over dues in other countries, recession in other

Countries, externalization problems, adverse exchange rates etc.

Government policies like excise duty changes, Import duty changes etc.

GENERAL METHODS OF MANAGEMENT OF NPAS:

The management of NPA is the difficult task in practice. Management of NPAs means, how to settle the NPAs account in the books. In simple it focuses on the methods of settlement of NPAs account. The methods differ from bank to bank. The following paragraph explains some general methods of Management of NPAs by the banks.

General Methods of Management of NPAs

Compromise:

The dictionary meaning of the term compromise is “settlement of dispute reached by mutual concessions. The following are the detailed guidelines for compromise/negotiated settlements of NPAs.

The compromise should be a negotiated settlement under which the bank should ensure recovery of its dues to the maximum extent possible of minimum expenses.

Proper distinction should be made between willful defaulters and borrowers defaulting in repayments due to circumstances beyond their control.

Where security is available for assessing the realizable value, proper weight age should be given to the location, condition and marketable title and possession of sub security.

An advantage in settlement cases is that banks can promptly recycle the funds instead of resorting to expensive recovery proceedings spread over a long period.

All compromise proposals approved by any functionary should be promptly reported to the next higher authority for post facto scrutiny.

Proposal for write off/ compromise should be made by a committee of senior executives of the bank.

Special recovery cells should be set up at all regional levels.

Legal remedies:

The legal remedies are one of the methods of management of NPAs. The banks observed that the borrower is making willful default; no more time should be lost instituting appropriate recovery proceedings. The legal remedies are filling of civil suits.

Regular Training Program:

All the levels of executives should under go the regular training program on credit and NPA management. It is very useful and helpful to the executives for dealing the NPAs properly.

Recovery Camps:

The banks should conduct the regular or periodical recovery camps in the bank premises or some other common places; such type of recovery camps reduces the level of NPAs in the Banks.

Write offs:

Write offs is also one of the common management techniques of NPAs. The assets are treated as loss assets, when the bank writes off the balances. The ultimate aim of the write off is to cleaning the Balance sheet

Spot Visit:

The bank officials should visit the borrowers’ business place or borrowers field regularly or periodically. It is also help full to the bank to control or reduce the NPAs limit.

Rehabilitation of potentially viable units:

The unit is sick due to technical obsolescence’s of inefficient management or financial irregularities. When the Bank settles the dues, of such, companies through the compromise or through the legal actions the better is to be followed.

Other Methods:

Persistent phone calls.

Media announcement.

ESTABLISHMENT OF COMMERCIAL BANKS

Banking was in existence in India from very early times. Modern banking started from 19^th century. The first commercial bank was started in India by the employees of East India Company called as agency office, mostly situated in the port cities most of them failed in their earlier periods of establishment only because of mismanagement and several other factors.

The first Joint Stock Bank to be set up in India was the bank of Hindustan, established at Calcutta under European management, even this failed the other Joint Stock Bank established in the same period were ‘Bank of Bengal’ 1806,”Bank of Bombay 1840 “Bank of Madras” 1843, called as presidency bank, with routine transaction they even had right to issue currency notes. They continued till 1921 then it were amalgamated under one head called imperial bank of India.

The Indian Commercial Banking system had to pass through a series of financial crisis and so in its growth during the half of 20^th Century, some banks progressed and some failed.

MEANING OF INDIAN COMMERCIAL BANKS

Indian Commercial Banks are those which are established under the Indian Companies Act 1956, and performed commercial banking business. They are governed not only by Indian Companies Act but also by ‘The Indian Banking Act 1949’ and ‘The Reserve Bank of India Act of 1934’.

Indian Commercial Banks are classified in to two categories

Scheduled Banks

Non Scheduled Banks

Scheduled Banks and Non Scheduled Banks:

Scheduled banks are those banks which are included in the II Scheduled of the Reserve Bank of India Act 1934.

Commercial Banks are included in the schedule only after satisfying the following conditions:

They should have a paid up capital and reserve of Rs 5 Lakh or more.

They should satisfy the Reserve Bank of India that their assets are not being conducted to the interest of their depositors.

If the above said two conditions are not satisfied by any of the bank established under the Indian company Act 1956, Banking Regulation Act, Reserve Bank of India Act are called as non scheduled banks.