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.
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