Non Performing Assets

1. a. EXECUTIVE SUMMARY The project is entitled â€Å"A study on The Management of Non-Performing Assets in the Canara Bank’s Loan Portfolio† is done at the Canara Bank, Donimalai Township, Sandur (TQ), Bellary (Dist), Karnataka State. INTRODUCTION: An efficient financial management is becoming inevitable for every manager in today’s corporate world. From a traditional aspect of raising funds whenever needed the importance has shifted to day to day financial decision making and problem solving.When initially the stress was on the internal analysis of the firm, procurement of funds, management of assets and allocation of capital, the present importance has shifted to decision making within the firm. With the modern aspect of finance function the responsibilities of the finance manager has also increased. In the process of making optional decision, he makes use of certain analytical tools in the analysis, planning and control activities of the firm. Financial analy sis is an essential prerequisite for making sound financial decisions.This study is intended to probe into the management of non performing assets in the Canara Bank’s Loan Portfolio, for the period of 2002-2003 to 2005-2006. The study is completely based on the analysis and interpretation of the published accounts of the bank and personal interview of the senior officials of the bank. OBJECTIVES OF THE STUDY: ? To evaluate the Canara Bank’s asset quality. ? To identify the effectiveness of the risk management system, undertaken by the bank. SCOPE OF THE STUDY: ? The scope of the study here was confined to the organization only. ? The study covers to find out the strategy required to reduce the NPAs.METHODOLOGY OF THE STUDY: ? Primary data. ? Secondary data. DATA ANALYSIS AND INTERPRETATION: When the data collected is completed the data is processed and the relevant information is obtained. The data collected is analyzed using various statistical tools like frequency d istribution, charts and percentage analysis. DURATION OF THE STUDY: This study is intended to probe into the management of non performing assets in the Canara Bank’s Loan Portfolio, for the period of 2003-2004 to 2005-2006. FINDINGS: ? The Net NPA ratio of the Canara Bank declined from 1. 88% as at March 31st 2005 to 1. 12% as at March 31st 2006. Canara Bank has recovered its NPA which is amounted to Rs. 865 crore during 2005-2006. ? The Net NPA of the Canara Bank declined from Rs. 1454 crore as on 31st March 2006. ? The Net NPA percentage of Canara Bank has reduced by over 19% during 2005-2006. RECOMMENDATIONS: ? Canara Bank should concentrate more on credit appraisal, monitoring, credit risk management and recoveries. ? Settlement is a better option for the banks wrestling with the problem of non-performing assets. ? Credit scoring allows lenders to determine whether or not you fit the profile of the type of customers they are looking for. Banks concerned should continuousl y monitor loans to identify accounts that have potential to become non-performing. CONCLUSION: ? Securitization Act will surely help banks in reduction of NPA to a great extent. ? Preventing fresh flow of NPAs to a great extent. ? Exchange of credit information among banks would be of immense help to avoid possible NPAs. 1. b. GENERAL INTRODUCTION: INDUSTRY PROFILE Banking in one form or another was in existence even in ancient times. The writings of Manu (the maker of old Hindu Law) and Kautilya (the Minister of Chandragupta Maurya) contained references to banking.However, banking as a kind of business i. e. , modern banking is of recent origin. It came into existence only after the industrial revolution. After the industrial revolution, with the increase in the size of industrial and business units, joint stock company people with small means to become shareholders of big industrial and business enterprises. Still, there were certain sections of public who were not prepared to inv est their money on the shares of joint stock companies. However they were willing to part with a little surplus money, if they were assured of the repayment of their money with a little interest thereon.So naturally, there arose the need for formation of financial institutions that could collect the surplus funds of people on terms acceptable to them and make them available to the needy for productive purpose. Accordingly a large number of financial institutions called joint stock banks were set up after industrial revolution. As such joint banks or modern banks are of recent development. MEANING OF BANKS: A banking company in India has been defined in the Banking Companies Act 1949 as â€Å"One which transacts the business of banking which means the accepting of he purpose of sending or investment of deposits of money form the public repayable on demand or otherwise and withdrawable by cheque, draft order or otherwise†. STRUCTURE OF BANKING SYSTEM IN INDIA: Indian Banking Sy stem has been categories into two: 1. Scheduled Banks. i. State Co-operative. ii. Commercial Banks. 2. Non-Scheduled Banks: Central Co-operative Banks and Primary Credit Societies. Commercial Banks. Commercial Banks are further divided into Indian Banks and Foreign Banks. Indian Banks are further divided into: 1. Public Sector Banks. 2. SBI and its Subsidies. 3. Other Nationalized Banks. 4. Regional Rural Banks.ACTIVITIES OF BANKS: I. Activities of Commercial Banks. II. Activities of Central Banks. I. Activities of Commercial Banks: The activities undertaken by commercial banks be subdivided into: a. Primary Functions. b. Subsidiary Functions. a. Primary Functions: i. Acceptance of deposits: It is very important for banks as it forms the basis of all other activities of banks. It accepts various types of deposits. They are current deposit, saving deposit, fixed deposit and recurring deposits. ii. Lending of Funds: It is also the most important function of Commercial Banks as it fetc hes the major portions of the income of the banks.Banks lend money by the way of loans, overdrafts, cash credit and discounting of bills. b. Subsidiary Functions: i. Agency Functions: The services rendered by banks as agent of their customers are called agency services. They are: †¢ Banks collect cheque, bank draft, bills, interest, dividends etc on behalf of the customer. †¢ Banks sells and purchases securities on behalf of the customers. †¢ Banks arranges for remittance of funds from one place to another place. †¢ Banks acts as trustees, executors, representatives of their customers. ii.General Utility Services: Services rendered by banks to their customers as well as the general public are called as general utility services. †¢ Banks accept precious articles, documents etc for safe custody. †¢ Banks helps exporters and importers in foreign trade. †¢ Banks issue travellers cheque, letter of credit, circular notes etc. †¢ Banks acts as a refe rence and supply information about the financial standing of the customers to others. II. Activities of the Central Bank: A. Monopoly of Note issue. B. Banker, Agent, Advisor to the government. C. Custodian of cash reserves of the banks. D. Lender of the last resort.FUNCTIONS AND IMPORTANCE’S OF BANKS: The importance of banks in the modern economy cannot be denied. Banks play a significant role in the economic development. Banks perform a number of functions. They are: 1. Banks mobilize the small scattered and ideal savings of the people, and make them available for productive purpose. In the sort, they aid the process of capital formation. 2. By accepting the savings of the people, banks provide safety and security to the surplus money of the depositors. 3. Banks provide a convenient and economical method of payment. The cheque system introduced by banks is convenient form making payments.Again the use of cheque economies the time and trouble involved in settlement of busine ss obligations. 4. Banks provide a convenient and economical means of transfer of funds from one place to another. Banks drafts are commonly used for remittances of funds from one place to another. 5. Banks helps the movement of capital from regions where it is no very useful to regions where it can be more usefully employed, by moving funds, banks increases the utility of funds. Again by moving funds from one place to another, banks contribute to the economic development of backward regions. 6.Banks influence the rates of interest in the money markets. Through the supply of money (i. e. bank money or bank deposits) banks expert a powerful influence on the interest rates in the money market. 7. Banks help trade and commerce industry and agriculture by meeting their financial requirements. But for the financial assistance provided by the banks, the pace of growth of trade and commerce industry and agriculture would have been very slow. 8. Banks direct the flow of funds into productio n channels. While lending money, they discriminate in favor of essential activities and against non essential activities.Thus they encourage the development of right types of activities which the society desires. 9. Banks always make it a point to help the industries, the prudent, the punctual and the honest and discourage the dishonest, the spendthrift, the gambler the lair and the knave (i. e. the rouge). Thus banks act as public conservators of commercial virtues. 10. Banks serves as the best financial intermediaries between the saver (i. e. the depositors or lenders) and the investor (i. e. the borrowers or the entrepreneurs). SERVICE PROFILE OF THE CANARA BANK: The bank has many financial services and different schemes.Important among them are as follows: DOMESTIC PRODUCTS SAVING BANK DEPOSITS: For individuals & non-trading organizations / institutions. CURRENT ACCOUNT: For business operations – trades, businessmen, corporate bodies. FIXED DEPOSITS: Secured way to high r eturns – individuals and institutions. KAMADHENU DEPOSITS: Re-investment money multiplier plan. CANBANK AUTO – RENEWAL: Higher return in a shorter plan. CANFLEXI DEPOSITS: A combination of savings & fixed deposits – high return & instant liquidity. ASHRAYA DEPOSITS: Respecting Indian values for senior citizens.RECURRING DEPOSITS SCHEME: Inculcating saving, a rewarding & recurring habit. FLOATING RATE DEPOSITS SCHEME (FRDS): Insures against interest rate fluctuations. LOAN PRODUCTS HOUSING LOAN SCHEME: Purchase of a ready built house / flat construction of house, purchase of a site and construction of house thereon, for undertaking repairs, renovations, upgradation, and creation of additional amenities and for taking over of the HL liability from other recognized housing finance companies and banks. HOME IMPROVEMENT LOANS: Furnishing the house / flat along with bank’s home loans / independently.CANMOBILE: Facilities purchase of new / used cards / jeeps of all make. The scheme also covers finance for purchase of brand new two wheelers. CANCARRY: Provided credit worthy individuals, professional and salaried class for buying consumer durables and household articles. CANCASH: Offer assistance for meeting unforeseen contingencies. Finance is granted against approved shares, bonds and debentures held by the clients. CANBUDGET: Fulfills the financial needs of confirmed employees of reputed PSU’s, joint stock companies, central / state / semi – government employees nd lecturers / professors / assistant professors of colleges / universities and research institutes. CANRENT: Provides loans to property owners whenever the property is leased / rented out to PSU’s central / state / semi – government undertakings. Reputed corporate banks. Financial institutions, Insurance companies and MNCs. CANMORTGAGE: Designed to meet the financial requirements against security of equitable mortgagee of property (land & building) to professional, businessman, salaried persons and individuals.VIDYASAGAR EDUCATIONAL LOAN SCHEME: Renders financial assistance for needy and meritous students for pursuing all type of studies (professionals / general) in India and Abroad. LOAN SCHEME TO TRADERS / BUSINESS ENTERPRISES: With hassle – free and minimum terms and conditions, the scheme cater to the needs of traders and other business enterprises for smooth flow of business activities. CANMAHILA: Exclusive loan scheme for women clientele. AGRI – LOAN SCHEME: Various loan schemes for agri-clinic, minor, irrigation, farm development / machinery, plantation crops fishers and for agro-exports.SSI LOAN SCHEME: A host of schemed available for technology up gradation fund in textile and jute industries, credit linked capital subsidy stand by credit for capital expenditure and margin money scheme of KVIC. OTHER PRIORITY SCHEME: These include loan for retail traders, small business, professional / self employed, medica l practitioners and loan for solar water heating / home lighting system. CREDIT CARD OPERATIONS †¢ The first Indian card issuers to bay ISO 9002 certification, CANCARD today as a distinct recognition in the domestic as well as international market. All verstors of CANCARD namely, CANCARD visa, classic, visa-corporate, master card and visa – international gold are issued through all CANARA BANK branches & 24 CANCARD service centers located at major cities across the country. †¢ Four Indian Banks are in affiliation with the bank for issue of CANCARD VISACARD. †¢ Launched DEBIT CARD on November 4, 2003, a value added and tech based product for its niche clients. CUSTOMER CENTRIC ETHOS †¢ CANARA BANK was the first to articulate the directive principles of good banking, detailing banker’s duties and customers rights. First bank to get ISO certification for one of its branches in Bangalore in the year of 1995-1996. †¢ Recommendations of the Goiporia Committee on Customer Service have been implemented by the bank. †¢ The bank has Computerized Information Facilitation Centers (CIFCs) at all circles to look exclusively into customer in a single window framework. †¢ A 24 hour tele – contact facility is also available for customers to air their grievances at corporate as well as circles levels. COMPANY PROFILE OF THE CANARA BANK: HISTORICAL TREND:Canara Bank established in 1906 with the name of Canara Bank Hindu Permanent Fund in Mangalore, India, by Ammembal Subba Rao Pai, is one of the oldest and major commercial bank of India. Its name was changed to Canara Bank Limited in 1910. The bank, along with 13 other major commercial banks of India, was nationalized on 19th July, 1969, by the Government of India. Currently (2005), the bank has 2508 branches spread all over India. The bank also has international presence in several centers, including London, Hong Kong, Moscow, Shanghai, Doha, and Dubai.In terms of business it is the largest nationalized commercial bank in India with a total business of about Rs. 2000 billion (about US $43 billion). ORGANISATION STRUCTURE: The bank has fourteen wings in the Head Office, Bangalore. 1. Personnel Wing 2. Corporate Credit Wing 3. Risk Management Wing 4. Priority Credit Wing 5. Inspection Wing 6. Department of Information Technology Wing 7. Marketing and Customer Relationship 8. Planning and Development Wing 9. Recovery Wing 10. General Administration Wing 11. Financial Management Wing 12. Treasury and International Operation Wing 13.Retail Banking and Subsidiaries Wing 14. Vigilance Wing OFFICE AND BRANCHES: Canara bank has a network of 2415 branches, spread over 22states/ 4 union territories of the country and overseas branch @ London which are administrated through †¢ Head Office at Bangalore †¢ 13 Circles offices / International Division †¢ 35 Regional offices †¢ 2441 Branches BRANCHES ABORAD: CANARA BANK established its Internation al Division in 1976, to supervise the functioning of it various foreign department to give the required thrust to Foreign Exchange business, particularly export and to meet the requirements of NRI’s.Though small in size the Bank’s presence abroad has brought in considerable foreign business, particularly NRI deposits. The presence of bank is shown under. †¢ CANARA BANK, London, UK (Branch) †¢ Indo Hong Kong International Finance Co Ltd Hong Kong (Subsidiary) †¢ AL Razouki International Exchange company , Dubai, UAE According to the latest information, both the CANARA BANK and State Bank of India have come into a mutual agreement as to both the banks will be operating as a one unit in the Moscow. CORPORATE VISION: To top as a World Class Bank with best practices in the realms of asset portfolio, Customer orientation, Product Innovation, Profitability an enhanced value for stake holders. †¢ To set new standards in IT application, Customer responsivene ss, Asset quality and profitability, culminating in higher stoke holder value. †¢ To scale new peaks in respect of IT based banking, efficient service delivery market leadership in profitability. CORPORATE MISSION: †¢ Augmenting low cost deposits. †¢ Toning up asset quality. †¢ Accent on cost control. †¢ Thrust on retail banking. †¢ Customer centric focus. Product innovation and marketing. †¢ Leveraging IT for comprehensive MIS. †¢ Maximize stockholder’s value. CORPORATE OBJECTIVE: E- Efficiency. P- Profitability and Productivity. O- Organization Effectiveness. C- Customers centric H- Hi Tech Banking ACHIVEMENTS: The Bank has already carved a niche in providing IT – based services. Computerized branches, for 65% of the branches & 81% of aggregated business provided a wide array of services such as Network ATM’s, any where Banking , Tele Banking & Remote Access Terminals etc. , The Bank was the first to launch networked ATM ’s & obtain ISO certification.CANARA BANK shares are listed & Bangalore, Mumbai & National Stock Exchanges. †¢ Establish well-developed quality circles have participated in many National & International level competitions and have returned with handsome prizes. †¢ Has set up its own Apex level Training colleges to its employees and thereby takes care of the knowledge, skills and attitudinal development of employees. †¢ Has also taken initiative in the environmental concerns. PERRFORMACE HIGHLIGHTS OF 2005-2006 †¢ Canara Bank has posted net profit of s. 581 cr for the half year ended September 2005 as against Rs. 19 cr during the corresponding previous half year, registered a growth rate of 38. 60%. †¢ The Bank operating profit registered an increase of Rs. 548 cr (57. 81%) to reach Rs. 1496 crore, up from Rs. 948 cr for the first half of the preceding financial. †¢ Return of assets a standard measure of profitability improved from 1. 08% (annuali zed) at a September 2002 to 1. 28% (annualized) as at September 2005. †¢ Number of branches moved up to 2441 from 2416 as at September 2002, besides 248 extension counter. †¢ Global deposits of the Bank aggregated to as Rs. 5, 396crore as against Rs. 67734 crore a year ago, year growth being 11. 31%. MATURITY CLASSIFICATION OF VARIOUS ASSETS AND LIABILITIES: In respects of the certain Assets and liabilities, CANARA BANK have undertaking a behavior study, embedded options in the basis of past of past data, based on which the bank is in a position to decide on the maturities of the asset and liabilities. 2. a. RESEARCH DESIGN A study on the Management of Non Performing Assets in the Canara Bank’s Loan Portfolio is done at the Canara Bank Donimalai Township, Sandur (TQ), Bellary (Dist), Karnataka State.The type of research used for the collection & analysis of the data is â€Å"Historical Research Method†. The main source of data for this study is the past recor ds prepared by the bank. The focus of the study is to determine the non-performing assets of the bank since its inception & to identify the ways in which the performance especially the non-performing assets of the Canara Bank can be improved. The data regarding bank history & profile are collected through â€Å"Exploratory Research Design† particularly through the study of secondary sources and discussions with individuals.Data Collection Method Discussion with the manager & officers of the bank to get general information about the bank & its activities. ? Having face to face discussions with the bank officials ? By taking guidance from bank guide & departmental guide. Secondary Data ? Collection of data through bank annual reports, bank manuals and other relevant documents. ? Collection of data through the literature provided by the bank. Research Measuring Tool: The tools used for data collection are: 1. Personal Interview 2. Secondary Sources 1. Personal Interview:In this, discussions more held directly with the manager & officials to get the clear-cut information about the topic and data to be collected for the purpose of analysis. 2. Secondary Sources: Annual company reports, Balance Sheets, Profit & Loss account are used to collect the data. b. 1. SATATEMENT OF THE PROBLEM: A crucial issue which is engaging the constant attention of the banking industry is the alarmingly high level of non performing assets (NPA). Another major anxiety before the banking industry is the high transaction cost of carrying non performing assets in their books.The resolution of the NPA problem requires greater accountability on the part of the corporate, greater disclosure in the case of defaults, an efficient credit information sharing system and an appropriate legal frame work pertaining to the banking system so that court procedures can be stream lined and actual recoveries made within an acceptable time frame. So the project titled â€Å"A study on the Management of Non Performing Assets in the Canara Bank’s Loan Portfolio† looks in to the implications of high NPAs and suggests effective recovery measures for resolving problem loans and thus making the banks NPAs level healthy.It also compares the position of the Canara Bank with other public sector banks in terms of their NPAs in the last three years and also to study the management of total assets and advances of the Canara Bank among other public sector banks. b. 2. OBJECTIVES OF THE STUDY: ? To evaluate the Canara Bank’s asset quality. ? To compare the position of the Canara Bank with other public sector banks in terms of their NPAs. ? To study the management of total assets and advances of the Canara Bank. ? To identify the effectiveness of the risk management system, undertaken by the bank. To analyze sector wise non-performing assets. ? To offer useful suggestions to reduce the NPA in banks. b. 3. SCOPE OF THE STUDY: ? The scope of the study here was confined to th e organization only. ? The study covers to find out the strategy required to reduce the NPAs. ? The concentration is given only in understanding the NPAs growth with the reference of Canara Bank. ? The data is purely based on the secondary data collected from website and journal. ? The scope is limited to drawn conclusions from analysis and interpretations of the primary and secondary data of the Canara Bank. . 4. METHODOLOGY: Introduction The quality of the project work depends on the methodology adopted for the study. Methodology, in turn, depends on the nature of the project work. The use of proper methodology is an essential part of any research. In order to conduct the study scientifically, suitable methods & measures are to be followed. Research Design The type of research used for the collection & analysis of the data is â€Å"Historical Research Method†. The main source of data for this study is the past records prepared by the bank.The focus of the study is to determ ine the non-performing assets of the bank since its inception & to identify the ways in which the performance especially the non-performing assets of the Canara Bank can be improved. The data regarding bank history & profile are collected through â€Å"Exploratory Research Design† particularly through the study of secondary sources and discussions with individuals. Data Collection Method Discussion with the manager & officers of the bank to get general information about the bank & its activities. ? Having face to face discussions with the bank officials ?By taking guidance from bank guide & departmental guide. Secondary Data ? Collection of data through bank annual reports, bank manuals and other relevant documents. ? Collection of data through the literature provided by the bank. Research Measuring Tool: The tools used for data collection are: 1. Personal Interview 2. Secondary Sources 1. Personal Interview: In this, discussions were held directly with the manager & official s to get the clear-cut information about the topic and data to be collected for the purpose of analysis. 2. Secondary Sources: Annual company reports, Balance Sheets, Profit & Loss account are used to collect the data. . 5. LIMITATIONS OF THE STUDY: ? The study is mainly based on the secondary data provided by the bank. As such it is subject to the limitations of the secondary data. ? The study is based only on NPAs with respect to loans. ? The study is based on the data given by the officials and reports of the bank. The confidentiality of some facts and figures is a limitation. ? The non-availability of relevant information is one of the limitations. ? The study is done only for the limited past 3 years. 3. THEORITICAL OVERVIEW NPA ITS IMPACT AND MAGNITUDE: MEANING OF NPA:An asset is classified as non- performing asset (NPA) if dues in the form of principal and interest are not paid by the borrower for a period of 180 days. How ever with effect from March 2004, default status woul d be given to a borrower if dues are not paid for 90 days. If any advance or credit facilities granted by bank to a borrower becomes non-performing, then the bank will have to treat all the advances / credit facilities granted to that borrower as non-performing without having any regard to the fact that there may still exit certain advances / credit facilities having performing status.A ‘non-performing asset’ (NPA) was defined as a credit facility in respect of which the interest and / or installment of installment of principal has remained ‘Past Due’ for a specified period of time. An amount due under any credit facility is treated as â€Å"past due† when it has not been paid within 30 days from the due date. Due to the improvement in the payment and settlement systems, recovery climate, up gradation of technology in the banking system, etc. , it was decided to dispense with ‘past due' concept, with effect from March 31, 2001. Accordingly, as from that date, a Non performing asset (NPA) shell be an advance where i.Interest and /or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan, ii. The account remains ‘out of order' for a period of more than 180 days, in respect of an overdraft/ cash Credit(OD/CC), iii. The bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted, iv. 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, and v.Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts. ’90 days’ overdue norm’ 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, form the year ending March 31, 2004 . Accordingly, with effect form March 31, 2004, a non-performing asset (NPA) shell be a loan or an advance where; i. Interest and /or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan, i. The account remains ‘out of order' for a period of more than 90 days, in respect of an overdraft/ cash Credit(OD/CC), iii. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, iv. 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, and v. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.As a facilitating measure for smooth transition to 90 days norm, bank has been advised to move over to charging of interest at monthly rests, by April 1, 2002. However, the date of classification of an advance as NPA sho uld not be changed on account of charging of interest at monthly rests. Banks should, therefore, continue to classify an account as NPA only if the interest charged during any quarter is not serviced fully with 180 days from the end of the quarter with effect from April 1, 2002 and 90 days from the end of the quarter with effect from March 31, 2004. Out of Order’ Status An account should be treated as ‘Out of Order’ if the outstanding balance remains continuously in excess of the sanctioned limit / drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit / drawing power, but there are no credits continuously for 180 days (to be reduced to 90 days, with effect from March 31, 2004) as on the date of Balance Sheet or credits are not enough to cover the interest debited the same period, these accounts should be treated as ‘out of order’. ‘Overdue’Any amount due to the bank und er any credit facility is ‘overdue’ if it is not paid on the due date fixed by the bank. Asset Type Percentage of Provision Sub standard (age up to 18 months)10% Doubtful 1 (age up to 2. 5 years)20% Doubtful 2 (age 4. 5 years)30% Doubtful 3 (age above 4. 5 years)50% Loss Asset100% INCOME RECOGNITION-POLICY: The policy of income recognition has to be objective and based on the record of recovery. Internationally income from non-performing assets (NPA) is not recognized on accrual basis but is booked as income only when it is actually received.Therefore, the banks should not charge and take to income account interest on any NPA. However, interest on advances against term deposits, NSCs, VIPs, KVPs, and Life policies may be taken to income account on the due date, provided adequate margin is available in the accounts. Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding debts should be recognized on an accrual basis over th e period of time covered by the re-negotiated or rescheduled xtension of credit. If Government guaranteed advances become NPA, the interest on such advances should not to be taken to income account unless the interest has been realized. REVERSAL OF INCOME: 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. This will apply to Government guaranteed accounts also.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 uncollected. THE CONCEPT OF GROSS NPA: Income recognition is not possible once an account becomes NPA. Interest accrued on non performing loan accounts is debited to the respective account and credited to the interest suspense account instead of t he profit and loss account. Usually no debits are permitted in non performing asset expect unavoidable expenditure like litigation expenses, insurance etc.Hence the balance outstanding in an NPA account includes: 1. Balance as on date of becoming an NPA. 2. Interest accrued but not realized. On balance sheet date banks make provisions for loan losses. This provision is calculated not on the balance outstanding but on the net balance, balance net of the amount kept in the interest suspense account. This book balance of the net of the interest suspense account is known as Gross NPA. But in cases where guarantee claim is received from credit guarantee corporations like ECGC, before making the provision for loan losses, such claim received is also netted from the gross NPA.The terminology net NPA indicates the balance in interest suspense account. For evaluation RBI and other rating agencies rely on purpose usually the net NPA balance. Thus Gross NPA means, balance outstanding minus bal ance in interest suspense account. Net NPA means: Gross NPA minus balance claim received amount and provision outstanding in that account. IMPACT OF NPA: At the Macro level, NPAs have chocked off the supply line of Credit of the potential lenders thereby having a deleterious effect on capital formation and arresting the economic activity in the country.At the Micro level, unsustainable level of NPAs has eroded current profits of banks and FIs. They have led to reduction of interest income and increase in provisions and have restricted and recycling of funds leading to various Asset Liability mismatches. Besides this, it has led to erosion in their capital base and reduction in competitiveness. The problem of NPA is not a matter of concern to banks and FIs alone. It is the matter of grave concern to the country and any bottleneck in the smooth flow of credit is bound to create adverse repercussions in the economy.The mounting menace of NPAs has raised the cost of credit, made Indian business man uncompetitive as compared to their counterparts in other countries. It has made banks more adverse to risks and squeezed genuine Small and Medium Enterprises (SMEs) from accessing competitive credit and has throttled their enterprising spirits as well, to a great extent. Due to their crippling effect on the operation of the banks, Asset quality has been considered as one of the most important parameters in the measurement of bank’s performance under the CAMELS Supervisory Rating System of RBI. THE MAGNITUDE:Non-Performing Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. The positive results of the chain of measures affected under banking reforms by the Government of India and RBI in terms of the two Narasimhan Committee Reports in this surging threat. Despite various correctional steps administered to solve and end this problem, concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on banking and financial institutions.The severity of the problem is however acutely suffered by Nationalized Banks, followed by the SBI group, and the all India Financial Institutions. As at 31. 03. 2004 the aggregate gross NPA of all scheduled commercial banks amounted to Rs. 63883 crore. Table No. 1 gives the figures of net NPA for the last three years. The ratio of net non-performing assets to net advances also declined during 2005-06. Majority of the banks, this ratio is less than 4 percent. Punjab and Sind Bank has the highest ratio with 9. 62 percent followed by Dena Bank of India with 9. 4 percent. 4 banks reported â€Å"nil† ratio during 2005-2006.Further it is revealed that commercial banks in general suffer a tendency to understate their NPA figures. There is the practice of ‘ever-greening’ of advances, through subtle techniques. As per report appear ing in a national daily the banking industry has under – estimated its non-performing assets (NPAs) by whopping Rs. 3862. 10 Crore as on March 1997. The industry is also estimated to have under-provided to the extent of Rs. 1,412. 29 Crore. The worst offender is the public sector banking industry. Nineteen nationalized banks have underestimated their NPAs by Rs. 3,029. 29 Crore.Such deception of NPA statistics is executed through the following ways. ? Failure to identity an NPA as per stipulated guidelines: There were instances of ‘sub-standard’ assets being classified as ‘standard’. ? Wrong classification of an NPA: Classifying a ‘loss’ asset as a ‘doubtful’ or ‘sub-standard’ asset, classifying a ‘doubtful’ asset as a ‘sub-standard’ asset. ? Classifying an account of a credit customer as ‘substandard’ and other accounts of the same credit customer as ‘standardâ€℠¢, throwing prudential norms to the winds. REASONS FOR NPAs: In Priority Sector Advances: 1.Directed and pre-approved natures of loans sanctioned under sponsored programmes. 2. Mis-utilization of loans and subsidies. 3. Diversion of funds. 4. Absence of security. 5. Lack of effective follow-up (Post sanction supervision and control) 6. Absence of Bankruptcy and fore-closure loans. 7. Decrepit legal system. 8. Cost in-effective legal recovery measures. 9. Difficulty in execution of Decrees obtained. In Non-Priority Sector Advances: 1. Inadequate credit appraisal. 2. Demand recession. 3. Industrial sickness and labor problems. 4. Slow Legal system. 5. Diversion of funds. 6.Willful default. 7. Technology Obsolescence. 8. Managerial inefficiency. 9. Political compulsion and corruption. WRITING OFF NPAs: In terms of section 43(D) of the Income Tax Act 1961, income by way of interest in relation to such categories of bad and doubtful debts as may be prescribed having regard to the guideli nes issued by the RBI in relation to such debts, shall be chargeable to tax in the previous year in which it is credited to the bank’s profit and loss account or received, whichever earlier. This stipulation is not applicable to provisioning required to be made as indicated above.In other words, amounts set aside for aside for making provision for NPAs as above are not eligible for tax deductions. Therefore the banks should either make full provision as per the guidelines or write-off such advances and claim such tax benefits as are applicable, by evolving appropriate methodology in consultation with their auditors / tax consultants. Recoveries made in such accounts should be offered for tax purposes as per the rules. WRITE-OFF AT HEAD OFFICE LEVEL: Banks may write-off advances at Head Office Level, even though the relative advances are still outstanding in the branch books.However, it is necessary that provision is made as per the classification accorded to the respective ac counts. In other words, if an advance is a loss asset, 100 percent provision will have to be made there for. DEBT RECOVERY TRIBUNAL: Any person aggrieved by any measure taken by secured creditor or his authorized officer may file an appeal to Debts Recovery Tribunal, within 45days from date on which such measure was taken. That is action of taking possession of asset, takeover of management of business of borrower, appointing person to manage secured asset etc. is taken by the creditor.When a borrower files an appeal, the appeal cannot be entertained unless, the borrower deposits 75% of the amount claimed in the notice by secured creditor. The DRT can waive or reduce the amount required to be deposited. The amount is not required to be deposited at the time of filing appeal, but appeal will not heard till the amount is deposited. The borrower while filing the appeal should also file an application requesting the Debt Recovery Tribunal to admit the appeal without deposit of any amoun t. If the DRT orders partial deposit of the amount and the same is not deposited, appeal can be dismissed.The 75% deposit is only required if the appeal is filed by the borrower. If some other aggrieved person (e. g. guarantor, shareholder) files it the deposit is not required. If a person is aggrieved by the order of the DRT, it can file an appeal to the Appellate Tribunal within 30days from the date of receipt of the DRT order. If the DRT or Appellate Tribunal holds that possessions of assets by the secured creditor was wrongful and directs the secured creditor to return asset to concerned borrower, the borrower shall be entitled to compensation and costs as may be determined by DRT or Appellate Tribunal.SECURITIZATION ACT: With the enactment of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002, banks can issue notices to the defaulters to pay up the dues and the borrowers will have to clear their dues within 60days. Once the b orrower 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 main purpose of this notice is to inform the borrower that either the sum due to the bank or financial institution be paid by the borrower or else the former will take action by way of taking over the possession of assets. Besides assets, bank can also takeover the management of the company. Thus the bankers under the aforementioned Act will have the much needed authority to either sell the defaulting companies or charge their management. OVERALL BANKING AND NPA BANKING REFORMS IN INDIA: The Nationalization of the major commercial banks in the year 1969 and 1980 had brought radical changes in the banking system in India.It had brought about major shifts in the priorities in the banking operations. Branch expansion policies of banks were tuned upto meet the banking needs of the people in rural and semi urban centers. For accelerating the socio-economic and rural development process several Governments sponsored programs were launched and lending in the priority sector, irrational lending under socio political pressures, mounting levels of bad debts, branch expansion at non viable centers etc. gradually started affecting the financial health of the banking sector in the country.Commercial banks were not following uniform accounting policies camouflaged the true financial position of banks. Quality of loan asset was not a concern and a high proportion of loan assets started becoming non performing. Most of the banks were under capitalized and some of them even with negative worth. Thus there was a compelling need for a change and various policy corrections had to be taken with the view of strengthening the economy. Thus the Government of India was forced to initiate a process of reforming the financial sector which banks constitute a dominant part. The reforms process inclu des: 1. Introduction of prudential norms. . Transparency in balance sheets. 3. Deregulation of interest rates. 4. Partial deviation from directed lending. 5. Upgradation of technology. 6. Entry of new private sector banks. NARASIMHAM COMMITTEE: The first phase of banking sector reforms was initiated in the year 1992 in pursuance of recommendations of the committee on financial sector reforms headed by Narasimham Committee. As per the recommendations of Narasimham Committee, The Reserve Bank of India introduced in a phased manner, prudential norms for income recognition, asset classification, and provisioning in the year 1998 Narasimham Committee-II came out with more tringent norms for the industry. The prudential norms were revised from time to time to fall in line with the best accounting practices and for transparency in published accounts. It is widely recognized that as a result of these reforms, the Indian Banking System is becoming increasingly mature in terms of the transfor mation of business processes and the appetite for risk management. Deregulation, technological upgradation and increased market integration have been the key factors driving change in the financial sector. EMERGING BANKING TRENDS:During the current financial year, the focus of non-going reforms in the banking sector was on soft interest rates regime, increasing operational efficiency of banks, strengthening regulatory mechanisms and on technological up-gradation. As a step towards a softer interest rate regime, RBI in its Annual Policy Statement had advised banks to introduced flexible interest rate system for new deposits, announce a maximum spread over PLR for all advances other than consumer credit and to review the present maximum spread over PLR and reduce them wherever they are unreasonably high. A BRIEF HISTORY OF NPA:The concept of Asset Quality on the books of Public Sector Banks (PSBs) and Financial Institutions (FIs) came into being when Reserve Bank of India (RBI) introd uced prudential norms on the recommendations of the Narasimham Committee in the year 1992-1993. The Committee recommended that an asset may be treated as Non-Performing Asset (NPA), if interest or installment of principal remains overdue for a period exceeding 180days and that banks and FIs should not take into their income account, the interest accrued on such Non-Performing Assets, unless it is actually received or recovered.The Committee also recommended that Assets be classified into four categories namely Standard, Sub-standard, Doubtful and Loss Assets and that certain specified percentage of the same be held as provision there against. Before the reform process, banks were booking income on an accrual basis and their balance sheets did not reflect their true specified financial health. Thus the profit, capital and reserves were overstated by them. After 10years of NPA terror in the banking industry, â€Å"Now the Banks Have Teeth†, a new law lightens the burden of bad loans for Indian Banks.The law that has been the catalyst for the bad loan clean up passed India’s Parliament in November 2002. It allows lenders to more easily foreclose on debtors assets or even demand a change in management. Within weeks of the law’s passage, banks saw a flood of loans once deemed unrecoverable being repaid in double time. The Act is The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Also know as the Securitization Act). This Act enables the setting up of asset management companies for addressing the problems of non-performing assets of banks and FIs.INDIAN BANKING AND NPA: The origin of the problem of burgeoning NPAs 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 an effective post-disbursement supervision. Banks concerned should continuously moni tor loans to identity accounts that have potential to become non-performing. The core banking business is of mobilizing the deposits and utilizing it for lending to industry.Lending business is generally encouraged because it has the effect of funds being transferred from the system to productive purposes which results into economic growth. However lending also carries credit risk, which arises from the failure of borrower to fulfill its contractual obligations either during the course of a transaction or on a future obligation. The history of financial institutions also reveals the fact that the biggest banking failures were due to credit risk. Due to this, banks are restricting their lending operations to secured avenues only with adequate collateral on which to fall back upon in a situation of default.GLOBAL NPA: The core banking is of mobilizing the deposits and utilizing it for lending to industry. Lending business is generally encouraged because it has the effect of funds bein g transferred from the system to productive purposes which results into economic growth. However lending also carries credit risk, which arises from the failure of borrower to fulfill its contractual obligations either during the course of a transaction or on a future obligation. A question that arises is how much risk can a bank afford to take? Recent happenings in the business world – Enron, WorldCom, Xerox, Global Crossing do not give much confidence to banks.In case after case, these giant corporates became bankrupt and failed to provide investors with clearer and more complete information thereby introducing a degree of risk that many investors could neither anticipate nor welcome. The history of financial institutions also reveals the fact that the biggest banking failures were due to credit risk. Due to this, banks are restricting their lending operations to secured avenues only with adequate collateral on which to fall back upon in a situation of default. It needs to be recognized that prudential norms in respect of loan classification vary widely across countries.A country follows varied approaches, from the subjective to the prescriptive. Illustratively, in the United Kingdom, supervisors do not require banks to adopt any particular form of loan classification and either is there any recommendation on the number of classification categories that banks should employ. Other countries, such as, the United States follow a more prescriptive approach, wherein loans are classified into several categories based on a set of criteria ranging from payment experience to the environment in which the debtor evolves.The adoption of such a system points to the usefulness of a structured approach those facilities the supervisor’s ability to analyze and compare banks loan portfolios. India is a better bet than China for investors to pump money into non-performing assets (NPAs) restructuring as it has better environment for recovery, according to consulti ng firm Price water House Coopers (PwC). WARNING: STANDARD & POOR: Standard & Poor’s and The Credit Rating Information Services of India Ltd. , (CRISIL) estimate that India’s schedule commercial banks require between US$11billion-US$13billion in new capital to support losses embedded in impaired assets.The significant capital shortfall estimated recognizes the existing moderate reported capital position of Indian banks, the inadequate loan loss reserves maintained by the banks to absorb likely losses. The weak capital position of the Indian banking system is largely a reflection of growing asset-quality problems stemming from weak underwriting and credit management system, and the vulnerabilities of the Indian banking sector to the impact of globalization on the country’s key industry sectors. The asset-quality position also has suffered from regulations with respect to lending to priority sectors. The capital shortfall calculated assumes a significantly higher system non-performing loan level to that reported under Indian regulatory standards,† said Peter Sikora, associate director, Financial Services Rating, Standard & Poor’s, together with CRISIL are, however, of the view that non performing loan levels for Indian banks will be significantly higher at 20%-25% if more conservative classification standards are adopted and restructured, and ever greened loans are included as impaired assets. LENDING BEHAVIOUR OF BANKS:Due to the excess liquidity in the banking system, banks are now giving credit to even non-priority sectors in an aggressive manner. Now banks give credit more to unproductive purposes, like car loans, housing loans, consumer durables loans and personal loans. This reckless lending paves the way to repayment irregularities and more of NPA in the banking system. But on the others side economy has become buoyant and the borrowers are now in a position to repay the loans even if it is an unproductive loan.Banks have improved their credit appraisal system. NPA percentage in City Bank’s Car Loan Portfolio is zero, because of the sophisticated credit appraisal system followed by the bank. Banks now give priority to ‘businesses’ and lending schemes also follow the path. CLASSIFICATION OF ASSETS: CATEGORIES OF NPAs: Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained non-performing and the realisability of the dues: a) Sub-Standard Assets. ) Doubtful Assets. c) Loss Assets. SUB-STANDARD ASSETS: A sub-standard asset was one, which was classified as NPA for a period not exceeding two years. With effect from 31March 2001, a sub-standard asset is one, which has remained NPA for a period less than or equal to 18 months. In such cases, the current net worth of the borrower / guarantor or the current market value of the security charged is not enough is not enough recovery of the dues to t he banks in full.In other words, such an asset will have well defined credit weakness that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. With effect from 31March 2005, a sub-standard asset would be one, which has remained NPA for a period less than or equal to 12 months. DOUBTFUL ASSETS: A doubtful asset was one, which remained NPA for a period exceeding two years. With effect from 31March 2001, as asset is to be classified as doubtful, if it has remained NPA for a period exceeding 18 months.A loan classified as doubtful has all the weaknesses inherent in assets that were classified as sub-standard, with the added characteristic that the weaknesses make collection or liquidation in full, – on the basis of currently know facts, conditions and values – highly questionable and improbable. With effect from 31March, 2005, an asset to be classified as doubtful if it remained in the sub-standard category for 12 months. 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. It should be noted that the above classification is only for the purpose of computing the amount of provision that should be made with respect to bank advances and certainly not for the presentation of advances in the bank balance sheet. The Third Schedule to the Banking Regulation Act 1949, solely governs presentation of advances in the balance sheet.Banks have started issuing notices under The Securitization Act,2002 directing the defaulter to either pay back the dues to the bank or else give the possession of the secured assets mentioned in the notice. Ho wever, there is a potential threat to recovery if there is substantial erosion in the value of security given by the borrower or if borrower has committed fraud. Under such a situation it will be prudent to directly classify the advances as a doubtful or loss asset, as appropriate. RBI GUIDELINES FOR CLASSIFICATION OF ASSETS:Broadly speaking, classification of assets into above categories should be done taking into account the degree of well-defined credit weaknesses and the extent of dependence on collateral security for realization of dues. Banks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value accounts. The banks may fix a minimum cut off point to decide what would constitute a high value account depending upon their respective business levels.The cut off point should be valid for the entire accounting year. Responsibility and validation levels for ensuring proper asset cla ssification may be fixed by the banks. The system should ensure that doubts in asset classification due to any reason are settled through specified internal channels within one month from the date on which the account would have been classified as NPA as per extent guidelines. UPGRADATION OF LOAN ACCOUNTS CLASSIFIED AS NPAs:If arrears of interest and principal are paid by the borrower in the case of loan accounts classified as NPAs, the account should no longer be treated as non-performing and may be classified as ‘standard’ accounts. Asset Classification to be borrower-wise and not facility-wise: i. It is difficult to envisage a situation when only one facility to borrower becomes a problem credit and not others. Therefore, all the facilities granted by a bank to a borrower will have to be treated as NPAs and not the particular facility or part thereof which has become irregular. ii.If the debts arising out of development of letter of credit or invoked guarantees are p arked in a separate account, the balance outstanding in that account for should be treated as a part of the borrower’s principal operating account for the purpose of application of prudential norms on income recognition, asset classification and provisioning. Accounts where there is erosion in the value of Security: i. A NPA need not go through the various stages of classification in cases of serious credit impairment and such assets should be straightaway classified as doubtful or loss asset as appropriate.Erosion in the value of security can be reckoned as significant when the realizable value of the security is less than 50 percent 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 straightaway classified under doubtful category and provisioning should be made as applicable to doubtful assets. ii. If the realizable value of the security, as assessed by the bank / approved valuers / RBI is less than 10 p ercent of the outstanding in the borrowal 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. RESTRCTURING / RESCHEDULING OF LOANS: A standard asset where the terms of the loan agreement regarding interest and principal have been renegotiated or rescheduled after commencement of production should be classified as sub-standard and should remain in such category for at least one year of satisfactory performance under the renegotiated or rescheduled terms.In the case of sub-standard and doubtful assets also, rescheduling does not entitle a bank to upgrade the quality of advance automatically unless there is satisfactory performance under the rescheduled / renegotiated terms. Following representations from banks that the foregoing stipulations deter the banks from restructuring of standard and sub-standard loan assets were reviewed in March 2001. In the contex t of restructuring of the accounts, the following stages at which the restructuring / rescheduling / renegotiation of the terms of loan agreement could take place can be identified: a) Before commencement of commercial production. ) After commencement of commercial production but before the asset has been classified as sub-standard. c) After commencement of commercial production and after the asset has been classified as sub-standard. PROVISIONING REQUIREMENTS: As and when an asset is classified as an NPA, the bank has to further sub-classify it into sub-standard, loss and doubtful assets. Based on this classification, bank makes the necessary provision against these assets. Reserve Bank of India (RBI) has issued guidelines on provisioning requirements of bank advances where the recovery is doubtful.Banks are also required to comply with such guidelines in making adequate provision to the satisfaction of its auditors before declaring any dividends on its shares. In case of loss asse ts, guidelines specifically require that full provision for the amount outstanding should be made by the concerned bank. This is justified on the grounds that such an asset is considered uncollectible and cannot be classified as bankable asset. Asset TypePercentage of Provision Sub-Standard (age upto 18 months) 10% Doubtful 1 (age upto 2. 5years) 20% Doubtful 2 (age 4-5years) 30%Doubtful 3 (age above 4-5years) 50% Loss Asset 100% THE NPA PROBLEM: The origin of the problem of burgeoning NPAs 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 an effective post-disbursement supervision. Banks concerned should continuously monitor loans to identify accounts that have potential to become non-performing. The performance in terms of profitability is a benchmark for any business enterprise including the banking industry.However, increasing NPAs h ave 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 t make provision on such assets as per the RBI guidelines. Also, with increasing deposits made by the public in the banking system, the banking industry cannot afford defaults by borrowers since NPAs affects the repayment capacity of banks. Further, RBI successfully creates excess liquidity in the system through various rate cuts and banks fail to utilize this benefit to its advantage due to the fear of burgeoning non performing assets.CREDIT APPRAISAL SYSTEM: Prevention of standard assets from migrating to non performing status is most important in NPA management. This depends on the style of Credit Management Mechanism available in banks. The quality of credit appraisal and the effectiveness of post credit appraisal and effectiveness of post credit follow up influences the asset quality of the banks in a big way. At Pre-Credit Stage: 1. Extensive enquiry about the character and the credit worthiness of the borrower. 2. Viability of the project to be financed is meticulously studied. 3. Adequate coverage of collateral is ensured to the extent possible. . Financial statement of the borrower is obtained and poor analysis of their financial strength is done. 5. Apart from the published financial statements independent enquires are made with previous bankers. 6. Pre-Credit inspection of the assets to finance is made. At Post-Credit Stage: 1. Operations in the account are closely monitored. 2. Unit visit is done at irregular intervals. 3. Asset verification is done on a regular basis. 4. Borrowers submit control returns regularly. 5. Accounts are periodically to evaluate the financial health of the unit. 6. Early warning signals are properly attended to. . Close contract with the borrower is maintained. 8. Potential NPAs are kept under special watch list. 9. Potentially viable units are restructured. 10. Repayment progra m of accounts with temporary cash flow problem is re