Bad loans: Banks sleeping at the wheel

Housing loan frauds have become commonplace. — Nagara Gopal

Competition has pushed banks into cutting corners, while checking the borrowers’ antecedents.

 M. SITARAMA MURTY  former MD, State Bank of Mysore.:BL :March 15, 2013:  

Non-performing assets (NPAs) have always been a part of the credit function in banks. It is only after the regulator introduced the concept of income recognition and provisioning in the 80s, tightening the definition of NPAs and provisioning norms, that they have assumed greater importance. 

Adoption of the Basel guidelines on capital adequacy made it a critical segment. For the third quarter of this year, most banks reported a decline in profits, citing the burgeoning NPAs. The fears of the rating agencies, which are sceptical about the assets quality and health of the banks, have been confirmed.

Gross NPAs showed signs of easing for a couple of years, but are moving menacingly towards the 4 per cent mark. The problem is so widespread that a CEO of a major PSB could defend the low profits as a fall-out of decline in asset quality, and not change in incumbency. Normal growth in credit could have, to some extent, improved the earnings and salvaged the ratios, but the economic slowdown and higher inflation and interest rates have dampened investments.

INCREASING FRAUDS

If a critical analysis is made, some worrying aspects do surface. Increasing number of frauds has contributed in no small measure to the problem. The acts of criminal minds in financial transactions, internal or external, including cyber crime, are labelled ‘fraud’ and are reported to the RBI. These do not, however, fully reflect the magnitude of the problem. 

A clear trend of defrauding the banks is emerging. The amounts lost in transaction frauds or theft pale into insignificance if the amounts involved in NPAs due to misrepresentation, falsification of accounts, diversion of funds, cheating, forgery and wilful default are considered.

Believing it to be safe lending, all banks pushed for housing loans in a big way. While percentages may provide a false comfort, the sheer number of cases where banks were cheated, some times several banks by the same person, with fake or forged documents runs into thousands. If the notices of sale or auction appearing in the press daily are any indication, many loans seem to have been granted without meticulous verification of the KYC norms, the earnings or the repayment capacity of the borrowers.

A common modus operandi of the fraudsters is to sell off the property or mortgage it to other banks, using multiple copies of the documents. In the era of colour printers it is difficult to make out the genuineness, except by a thorough verification at the registration office. This is time-consuming and beset with practical difficulties, too. With the records not updated in some States even for 5 to 7 years and there being no system of issuing encumbrance certificates in some others, it reads like a horror story. The advocates have to wade through voluminous haphazardly stored papers to verify.

WILFUL DEFAULT

The number of camouflaged fraudulent borrowings in the trade, manufacturing and services sectors is on the upswing. What is more alarming is that an increasing number of large value or corporate borrowers are resorting to false information and fake or forged documents for obtaining credit.

The failure of the banks to make a critical and realistic appraisal of credit needs and have efficient credit management practices at all levels, makes it that much easier for a dishonest borrower. Banks have to help themselves by not rushing through the sanctions, in the name of competition. It is a paradox that applicants still complain about delays.

Prudence or due diligence need not result in delays. But negligence of basics of banking can lead to frauds. Outsourcing most functions such as project appraisal, verification of documents, inspection of securities and their valuation, scrutiny of accounts and books, verification of stocks, internal audit and even recovery, have the bankers lost their professional touch? Is it because of volumes or reluctance to face accountability?

Realising that the entire exercise of recovery is ending in knots, the government and the RBI thought it fit to have a national register of bank mortgages as a self-help measure. But it will take time to stabilise, as in many States, the revenue and municipal records need to be streamlined and updated. Promotion of Credit Information Bureau (CIBIL) for building the credit history of borrowers is another initiative by the RBI.

SLOW RECOVERY

The recovery process is slow and painful, despite creation of DRTs and introducing the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI). Several borrowers become wilful defaulters, only to take advantage of the one-time settlement (OTS) system and gain. Having enjoyed the funds, interest apart, they bargain for discount in the principal. Anxious to reduce NPAs and at their wits end, finding no better alternative, banks fall for the OTS bait, sacrificing substantial amounts.

The DRTs and the SARFAESI act procedures involve interventions of police and revenue machinery and finally courts, leading to delays up to several years. The work load has also multiplied manifold over the years. Stays are sought and granted routinely, rendering the process ineffective. DRTs frequently stay proceedings under the SARFAESI Act which is not envisaged.

The Board of Industrial and Financial Reconstruction, which was to be wound up, is going strong and promptly stays recovery proceedings, unable to dispose of the cases for years on. Borrowers know this too well and after several years, throw the bait of OTS at the frustrated bankers.

If some banks successfully reach the stage of disposal of properties, influential defaulters ensure that no one participates in the auctions. For fear of litigation about the price and procedure, banks shy away from private sale. They settle for sale of debts to asset recovery and management companies at deep discount, as a last resort.

ILLUSIVE SECURITIES

Only banks with security of immovable property can hope to recover some dues. Traditionally, stocks of goods or commodities, machinery and book debts were considered good liquid securities.

But not any more. Once an account is irregular or becomes an NPA the stocks do a vanishing trick or the banks find them of no value. Mostly machineries and fixtures are either not available or of only scrap value, by the time the bankers could lay their hands on them, overcoming the various hurdles.

Book debts are like mirages; either mere statements submitted by the borrowers or the certificates given by the chartered accountants. Bankers seem to have forgotten the skill of verifying and monitoring the book debts. No details of transactions or contact particulars or any supporting documents are available with the banks.

Banks cannot deny credit for want of securities, particularly if there are not any. The RBI and governments prodding the banks to achieve targets for sectors such as exports, even those who have enough means, avoid offering any securities. Thanks to Export Credit Guarantee Corporation (ECGC), some relief is at hand. Ultimately, it boils down to banks substantially upgrading their appraisal skills and monitoring methods of scrutiny, verification, checks and cross checks. Self-help is the best help.

They need to look more inwards.

The author is former MD, State Bank of Mysore.

Dues and woes

Source : Vandana : The Week :Saturday, December 3, 2011 14:22 hrs IST 


Debt recovery officers of public sector banks are a worried lot these days.


 Reason: the escalating number of loan defaulters. The banking sector, which is already under pressure from frequent rate hikes, now has another problem to tackle—the non-performing assets. Public sector banks particularly are facing a hard time containing them, as a part of their NPAs is on account of non-payment by government-owned entities.

An NPA is an asset which does not produce income. A loan for which interest is 90 days overdue is classified as NPA. Gross NPAs of listed banks crossed Rs:1 trillion in the quarter ended in September, 33 per cent higher than a year ago. According to the Reserve Bank of India, the total NPA of state-run banks was Rs:747 billion, 2 per cent of their total lending corpus, till last December. 

Banks' asset quality has become a major concern for the RBI and it has asked lenders to monitor and tighten their credit management systems. “Rising interest rates and substantial amount of restructuring done during the crisis period, if not done with due care, are likely to put further pressure on asset quality of banks,” said a recent RBI report.

The results for the quarter ended in September of most public sector banks were below expectations owing to the mounting NPAs. Higher NPAs require banks to do higher provisioning (which means setting aside capital for loans that have gone bad), locking up a significant amount of capital and eroding profitability. Under the current provisioning norms, banks have to maintain funds ranging from 10 per cent for substandard assets to 100 per cent for assets under ‘loss category'.

“Banks also need to maintain the provision coverage ratio of 70 per cent of gross NPAs. Provisions eat into your capital generation. It is going to be a tightrope walk for banks to manage the NPAs,” said Vaibhav Aggarwal, research analyst, Angel Broking. India's largest lender State Bank of India's provisioning of bad loans stood at Rs:4,664 crore at the end of September, an increase of 21 per cent over the corresponding period a year ago.

The economic downturn in the west is one of the major reasons for the increase in non-performing loans. Profit margins of many businesses have shrunk, leading them to default on loans. “There are clear signs of slowdown in the Indian economy as well. Exports grew by only 10.8 per cent, the lowest in the last two years. Indirect tax collections have dropped by 2.5 per cent and the index of industrial production (IIP) has dipped by 1.9 per cent. The business climate has become gloomy and even though there is no intention to default, companies are unable to pay up on time,” said Robin Roy, associate director (financial services), PricewaterhouseCoopers.

The frequent increase in interest rates is another problem. Many companies that announced the second quarter results recently have identified the increasing interest cost as one of the major reasons for their profitability going down. The RBI hiked key rates 13 times in the last 20 months. 

International rating agency Moody's has raised red flag on public sector banks' spiralling NPAs, and changed its outlook on the banking sector from “stable” to “negative”. “With asset quality, given the tightening environment, we anticipate that it will deteriorate over the next 12-18 months, thereby causing an increase in provisioning needs for the banks in FY2012 and FY2013,” said Vineet Gupta, vice-president and senior analyst at Moody's.

Interestingly, the computer-based recognition of NPAs, to which all banks had to shift by September 30, has added to the banks' woes. Computer-based NPA recognition removes the subjectivity that the banker may exercise in classifying a loan as non-performing. “The system recognition has given a number of new NPAs. But, our recovery teams are very active. We have started debt resolution branches and centres to support them. Retail borrowers are still turning up to pay as they are in a better shape but the problem is with corporates and small and medium enterprises,” said an SBI official.

Also, a large number of loans that were restructured in 2007-08 have come to haunt public sector banks. Some of these loans have now become NPAs. There are various ways of restructuring a loan, such as allowing customers to postpone their interest payments until business prospects improve, increasing the tenure of the loan or, in case of corporates, converting debt into equity. If a company goes for a second round of restructuring, it is calculated as NPA on the bank's books. Restructured loans that turned bad accounted for 17 per cent of loans of 10 major banks.

A part of the stress on public sector banks' balance sheet is due to the exposure to sick government-owned entities, such as Air India and state electricity boards (SEBs). The national carrier has a debt of Rs:46,950 crore in a consortium of 20 banks. Its annual interest payment on this debt is around Rs:1,800 crore. Air India, which has accumulated losses of Rs:20,000 crore, has been in a poor shape for quite a while, raising question marks on receivables to the banks.

The whole aviation sector, in fact, could dent the asset quality of banks, say experts. “All the aviation companies are bleeding and we have seen the Kingfisher fiasco recently. The government will have to take some serious steps to save the airlines and banks that have lent to them,” said Roy.

Some other sectors are also under stress. “Textile, infrastructure and power are the sectors where one could see some stress. But, we have not stopped fresh loans. We have to support the industry and are disbursing loans on a case-to-case basis,” said S.K. Verma, general manager, Union Bank of India. 

In October, rating agency Crisil cautioned that lenders would be risking about Rs:56,000 crore unless the government brought about urgent reforms in the power sector. SEBs are staring at huge losses as a result of selling power at subsidised rates and mounting transmission and distribution losses. Though the loans to SEBs have not yet become NPAs, analysts are concerned about them. 

“We don't expect government entities to be stressed assets on our books. Some of them could go for restructuring,” said M. Sridhara, deputy general manager, Canara Bank. Punjab National Bank has already restructured its loan of Tamil Nadu State Electricity Board.
According to the RBI, the agricultural sector contributed 44 per cent of the total incremental NPAs of domestic banks in 2010-11. Another major contributor is the SME sector. SMEs have been severely affected by the downturn and most of them are under financial distress.

CPI(M) leader Gurudas Dasgupta, who had come out with a report cautioning the government on spiralling NPAs in 2005, has a different take on the issue. “There is a lack of political will on the part of the government to move on this issue,” he said. “There should be more aggressive recovery of corporate loans by banks as these loans constitute a major portion of the NPAs of banks. There should be enough security to cover the loan. Banks should be more prudent while lending to corporates.”

In contrast, private banks have been able to reduce their net NPAs. They reduced their accumulated net NPAs from Rs:6,972 crore in 2008-09 to Rs:3,871 crore in 2010-11. Said Aggarwal, “Private sector banks have been in a consolidation mode and are lending more wisely. Private banks can change their business mix more quickly, plus their productivity and efficiency are better.”

Are Non Performing Assets Gloomy from Indian Perspective ?

By : Arpita on 14 February 2010

 

Introduction :
When a borrower, who is under a liability to pay to secured creditors,
 makes any default in repayment of secured debt or any installment thereof, the
 account of borrower is classified as nonperforming assets (NPA) .NPAs cannot
be used for any productive purposes because they reflect the application of scarce
capital and credit funds. Continued growth in NPA threatens the repayment capacity
 of the banks and erodes the confidence reposed by them in the banks.

 In fact high level of NPAs has an adverse impact on the financial strength of
 the banks who in the present era of globalisation, are required to conform to
stringent International Standards. “Non Performing Asset” means an asset or
account of a borrower, which has been classified by bank or financial institution
 as substandard, doubtful or loan asset . After nationalisation and globalisation
the initial directive that banks were given was to expand their branch network,
increase the saving rate and extent credits to rural, urban and the most important
SSI sectors .

 No doubt this mandate has been achieved admirably under the regulation
 of economic reforms initiated in 1991 by the then Finance Minister and
present Prime minister Dr. Manmohan Singh. No doubt it would have been
incomplete without the overhaul of Indian Banking System.

 Then all of a sudden focus shifted towards improving quality of
 assets and better risk management. The Narasimhan committee
 reports (First report) recommendations are the basis for initiation of
the process, which is still continuing. The committee has recommended
 the enactment of a new legislation for securitisation and empowering banks
 and financial institution to take possession of the securities and do sell them
 without the intervention of the court.

The Narasimham Committee Report



the Narasimham Committee report  is without doubt a
major path- breaking piece of work and deserves
 the support of all who yearn for a more rational and effective banking
system in this country. In order to have the proper understanding of NPA
menace, it is important to have a brief idea of growth and structural changes
 that have taken place in the banking sector.

The growth of the banking system can be assessed in five phases:-
1) Preliminary Phase(series of birth and death of banks)
2) Business Phase(period between 1949- 19 69)
 3) Branching Out Phase(period when commercial banks got nationalised)
4) Consolidated phase(weaknesses and defects were identified)
 5) Reforms and Strengthening Phase(1991 to till date) Indian Banking Industry Saddled with High NPAs:

 Reasons:
The liberalization policies launched in 1991 opened
the doors to the entrepreneurs to setup industries and business,
 which are largely financed by loans from the Indian banking systems.

 Business firms and companies fail to pay the principal amount as well
as the interest amount (Bad Loan) . In the global economy prevailing today,
the vulnerability of Indian businesses has increased.

A culture change is crept in where repayment of bank loans
 is no longer assured. A constant follow up action and vigil are to
 be exercised by the operating staff. Diversion of funds and willful
 default has become more common. As per a study published in
the RBI bulletin in July 1999, diversion of funds and willful default are
 found to be the major contributing factors for NPAs in public and private
sector banks.

 Today, the situation looks optimistic with the industry succeeding
 in overcoming the hurdles faced earlier. The timely restructuring and
rehabilitation measures have helped to overcome setbacks and hiccups
 without seriously jeopardizing their future. The greater transparency and
stricter corporate governance methods have significantly raise the credibility
 of the corporate sector. The attrition rate in corporate sector has come down.

 The challenges before the banks in India today are the raising NPAs in the
 retail sector, propelled by high consumerism and lowering of moral standards.

Other Factors:
The problem that India faces is not lack of prudential norms but the legal
impediments and time consuming nature of asset disposal process ,
 ‘postponement’ of the problem in order to report high earnings and to
 some extent manipulation of by the debtor using political influence.

Most of the banks in India are into this malpractices and fraudulent acts.
 In the process of earning high returns on their investment by the above
stated method, the banks become bankrupt or penniless.
 A vicious effect of the slow legal process is that banks are shying
away from risks by investing a greater than required proportion of their
 assets in the form of sovereign debt paper.

The worst part is that the NPA of a private enterprise is
 both financially and politically undesirable.

 Earlier bankruptcy Law favored borrowers and law courts
were not reliable vehicles. But the circumstances have changed.
Laws were passed allowing the creation of asset management companies,
foreign equity participation in securitisation and asset backed securitization.

 Impact of NPAs on Banking Operations:

The efficiency of a bank is not reflected only
 by the size of its balance sheet but also the
level of return on its assets. The NPAs do not
 generate interest income for banks but at the same
time banks are required to provide provisions for NPAs
 from their current profits.

The NPAs have deliterious impact in the interest income on the bank,
bank profitability because of the providing of the doubtful debts, return
on investment of course.

NPAs also disturb the Capital Adequacy Ratio (CAV)
and economic value addition (EVR) of the banks.

 It is due to above factors, the public sector banks
are faced with bulging NPAs which results in lower
 income and higher provisioning for doubtful debts and
it will make a dent in their profit margin.

In this context of crippling effect on banks operation
 the slew asset quality is placed as one of the most
 important parameters in the measurement of banks
 performance under the Camel’s supervisory rating system
of RBI. Whether trading of NPA between Banks illegal or not:
 The word ‘trading’ here means purchasing or selling of NPAs
 between banks. So assignment or trading falls under the guidelines
of Banking Regulation Act (BRA) which makes it legal .

But the Gujarat High court has recently held that the buying
 and selling of non performing assets is illegal.

The court has ruled that such an activity is not a part of “banking activity”
as contemplated under the Banking Regulation Act, 1949.

The court held that “Interse transfer of NPAs by banks is illegal
 and not a part of banking activity under the BR Act.

Trading in debts is a speculative form of transaction that is not
 permissible activity and thus, cannot be a part of the business of a
 banking system” The ruling had an impact of sending shockwaves through
 the backbone of Indian economy and came under the greater scrutiny
 in academic circles too.

 But the judgment is yet to stand the Supreme test
 of judiciary scrutiny as the aggrieved Banks and concerned
regulatory bodies (RBI and Indian Bank Association) have challenged
 the decision before the Supreme Court. In the interim, the legality of
 loan purchases is under cloud till now. I feel the recent pronouncement
 of the Gujarat High Court has misinterpreted the term ‘debt’ from legal as
 well as accounting point of view. A loan item or the borrower is an asset of
a bank and not a debt. Thus, de-facto the assignment of loan (good or bad)
 amounts to transfer of asset and not debt.

Even RBI considers interse NPA assignment between banks
to be a significant tool for resolving the issue of Non Performing
Assets and in the interest of Banking policy .

The decision given by the Honorable Courts in the cases
that have been cited below (footnote16) were in favor of “assignment of NPAs
between banks.

Measures to control NPAs menace:
 A lasting solution to the problem of NPAs can be achieved
only with proper credit assessment and risk management
mechanism. It is necessary that the banking system is equipped
 with prudential norms to minimize if not completely avoid the problem
 of credit risk.

 Effective management of NPA rather than elimination is prudent.

All these issues gave the passage of evolution of the Securitisation
 and Reconstruction of Financial Assets and enforcement of
 Security Interest Act (SARFAESI), 2002 .

 It is a unique piece of legislation which has
 far reaching consequences. Securitisation
in India is still in a nascent stage but has potential
in areas like mortgage Backed securitisation.

 This act has a overriding power over the other
legislation.
SARFAESI ACT was promulgated
 to regulate the financial assets and enforcement of
 security interest and for matters connected therewith or
incidental thereto. The main purpose of this act is to enable the creditors
take possession of the secured assets and to deal with them without the
intervention of the court.


 No doubt this Act was challenged in various courts
 on ground that it was loaded heavily in favour of lenders,
 giving little chance to the borrowers to explain their views
 once recovery process is initiated under the legislation.

The major problem with the Indian banking system is that they
depend largely upon lending and investments.
The banks in the developed countries do not depend
 upon this income whereas 86 percent of income of Indian
 banks is accounted from interest and the rest of the income
 is fee based. The banker can earn sufficient net margin by investing
 in safer securities though not at high rate of interest.
It facilitates for limiting of high level of NPAs gradually.

It is possible that average yield on loans and advances net
 default provisions and services costs do not exceed the
 average yield on safety securities because of the absence of
 risk and service cost. The corporate debt restructuring is also
one of the methods suggested for the reduction of NPAs.


 Its objective is to ensure a timely and transparent mechanism
 for restructure of corporate debts of viable corporate entities
 affected by the contributing factors outside the purview of DRT
 and other legal proceedings for the benefit of concerned.
 The problem of non -performing loans created due to systematic
banking crisis world over has become acute.

Focused measures to help the banking system to realise its NPAs
has resulted into the creation of specialised bodies called Asset
Management Companies which in India have been named Asset
 Reconstruction Companies (ARC’s)

The main objective of ARCs is to act as
1) A agent for any bank or financial institution for the purpose
 of recovering their dues from the borrowers.
 2) A manager of the borrowers’ asset taken over by banks or financial institution.
3) The receiver of properties of any bank or financial institution.
4) There have been instances of banks extending credit to doubtful debtors
 (who deliberately default on debt) and getting kickbacks for the same.
Ineffective Legal mechanisms and inadequate internal control
mechanisms have made this problem grow – quick action has
to be taken on both counts so that both the defaulters and the
 authorising officer are punished heavily. Without this, all the
mechanisms suggested above may prove to be ineffective.

 Conclusion

The contaminated portfolio is definitely a bane for any bank.
 It puts severe dent on the liquidity and profitability of the bank
where it is out of proportion.

It is needless to mention, that a lasting
solution to the problem of NPAs can be achieved only with proper credit
 assessment and risk management mechanism. It is necessary that the
banking system is to be equipped with prudential norms to minimize if not
 completely to avoid the problem of NPAs.

The onus for containing the factors
 leading to NPAs rests with banks themselves. This will necessitates organizational
restructuring, improvement in the managerial efficiency and skill up gradation for proper
assessment of credit worthiness

It is better to avoid NPAs at the nascent stage of credit
consideration by putting in place of rigorous and
appropriate credit appraisal mechanisms.