NPA IN BANKS WITH REFERENCE TO SARFAESI ACT, 2002
Introduction
The banking industry in India has been witnessing a series of revolutionary changes and noteworthy transformation since 1991 after introduction of LPG policy and new economic and financial sector reforms. The process of Liberalization aimed to free banks from too much of regulations. The focus was on self-regulation. Self-regulation requires prudential norms to be laid down. On the eve of economic reforms in 1991, it was recognized that the banks were burdened with huge amount of Non-Performing assets (NPA's), The concept of NPAs emerged as a on temporary issue when Reserve Bank of India (RBI) introduced the prudential norms on the recommendations of the Narsimham committee in the year 1992-93. The prudential norms as laid down by RBI states that “An asset is considered as Non Performing if interest or installment of principal due remains unpaid for more than 90 days”. In simple words as long as the expected income is realized from the assets, it is treated as performing asset but when it fails to generate income or deliver value on due date, it is treated as non performing asset”. With a view to moving towards International best practices and to ensure greater transparency, the“90 Days overdue” norm for identification NPAs had been adopted from the year ending 31st march, 2004.
The ever increasing NPAs of Indian Banking industry arises due to faulty lending policy and making compulsion lending to priority sector by banks. Faulty credit management like defective credit in recovery mechanism, lack of professionalism in workforce, improper selection of Borrowers/activities, unscientific repayment schedule and misutilisation of loans by the users cause the emergence of the NPAs. Untimely communication to the borrowers regarding their due date and lack of sponge legal mechanism, weak credit appraisal system, industrial problems and recession in market etc also causes NPAs to rise I n the banking industry.
Scope of Law & Understanding SARFAESI Act:
The law did little until it discovered the magnamity of NPA’s impact on the profitability of the bank. SARFAESI ACT was formed in Dec’ 2002 based on recommendations of a) Committee on Banking Sector reforms (Narasimham Committee Report II) and b) Restructuring of Weak Public sector Banks (Verma Committee) . This Act aims at speedy recovery of defaulting loans and to reduce the mounting levels of Non-performing Assets of banks and financial institutions. The provisions of the Act enables the banks and financial institutions to realize long-term assets, manage problems of liquidity and asset liability disparities and to improve recovery by exercising powers to take possession of securities, sell them and reduce non-performing assets by adopting measures for recovery or reconstruction.
The Act provides three alternative methods for recovery of non-performing assets,viz;
ï‚· Securitization
ï‚· Asset Reconstruction
ï‚· Enforcement of Security without intervention of the court
Securitization:
Securitization implies the issue of security receipt by raising of funds or receipts by SCs / ARCs. The Securitization company or Reconstruction company raises from the Qualified Institutional Borrowers (QIBs) by way of schemes to acquire funds. They have to maintain proper book of accounts separately for each and every acquiring assets on the investments made by QIBs. Qualified Institutional Buyers are those who have expertise and sound knowledge to evaluate and make their investment in the Capital Markets.
Assets Reconstruction:
Assets Reconstruction companies buy the NPAs from Banks and take measures to recover the bad loans amount from the borrowers and also empower with,
ï‚· Proper Management of the borrower business,
ï‚· Change of management in the business
ï‚· Take Over
ï‚· Sale or lease ,
ï‚· Restructuring the business of the borrower,
ï‚· Rescheduling of the repayments of debts payable by the borrower ,
ï‚· Possession of Secured assets.
ï‚· RBI permitted ARCs to convert the debt / outstanding loans of borrowers in to “ Equities” as a functional process of restructurings the loan amount of NPAs.
ï‚· Shareholding shall not exceed 26% of the post converted Debt Equity as a reconstruction.
ï‚· The companies under equity reconstruction, as a part of Enforcement of Security interest, the permission given by Secured Creditors holding should not be less than 60% of the amount outstanding to a borrower as against 75% as on date.
ï‚· The amount recovered through this process will used by ARCs, to reconstruct the company’s management.
FRAMEWORK OF NPAS
The concept of NPAs originated when Reserve Bank of India introduced ‘prudential norms, on the recommendations of the Narashimam Committee in the year 1992-93. As per the prudential norms laid down by RBI,” An asset is considered as “ non-performing” if interest on installments of principal due remain unpaid for more than180 days(from March31,2004, it has been decided to adopt the ,90 days, overdue norm for identification of NPAs).
In simple words, as long as the expected income is realized from the asset, it is treated as performing asset but when it fails to generate income or deliver value on due date it is treated as non-performing asset. Growth of non-performing assets on the balance sheet of banks erodes the solvency, profitability and financial health of banks.
With a view to moving towards international best practices and to ensure greater transparency, 90 days overdue norm for identification of NPAs instead of 180 days has been adopted from the year ending March 31st 2004. Accordingly, a non-performing asset would 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;
II. The account remain ¸out of order, in respect of overdraft/cash credit;
III. The bill remain overdue for a period of more than 90 days in case of bill 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 purposes; and
V. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts. (Any amount due to the bank under any credit facility is “Overdue” if it is not paid on the due date fixed by the bank).
Banks have been advised by the RBI that they should identify the non-performing assets and ensure that interest on such assets is not recognized as income and taken to the profit and loss account. Banks are to recognize their income on accrual basis in respect of income on performing assets and on cash basis in respect of income on non-performing assets. Any interest
accrued and credited to income account must be cancelled by a reserve entry once the credit facility comes under the category of non-performing assets.
Assets Classification and Provisions
Banks are required to classify the loan assets (advances) into four categories viz.
I. Standard assets
II. Sub-standard assets
III. Doubtful assets; and
IV. Loss assets
Standard Advances/Assets: are those, which do not disclose any problem and do not carry more than normal risk attached to the business. Such assets are considered to be performing asset. A general provision of 0.25% has to be provided on global loan portfolio basis.
Sub-Standard Advances: With effect from 31 March 2005, a substandard asset would be one, Which has remained NPA for a period less than or equal to 12 months. Such an asset will have well defined credit weaknesses that jeopardize liquidation of the debt and are characterized by distinct possibility that bank will sustain some loss. Accordingly a general provision of 10% on outstanding has to be provided on substandard assets.
Doubtful assets- These are the assets which have remained NPAs for a period exceeding 12 months and which are not considered as a loss advance. Banks have to provide 100 percent of the unsecured portion of the outstanding advance after netting realized amount in respect of DICGC scheme (Deposit Insurance and Credit Guarantee Corporation) and realized/realizable amount of guarantee cover under ECGC (Export Credit Guarantee Corporation) schemes.
Loss Assets – Loss assets are those where loss has been identified by the bank or internal /external auditors or RBI inspectors but the amount has not been written off, wholly or partially. Any NPAs would get classified as loss assets if they were irrecoverable or marginally collectible and cannot be classified as bankable asset. Companies have to provide 100% of these outstanding advances.
Note: provision towards standard assets should not be deducted from advances but shown separately as contingent provisions against standard assets under “Other liabilities and provisions” others in schedule V of the balance sheet.
Reasons for Development of NPAs in Banks
An account does not become an NPA overnight. It gives signals sufficiently in advance that steps can be taken to prevent the slippage of the account into NPA category.
An account becomes an NPA due to causes attributable to the borrower, the lender and for reasons beyond the control of both. An internal study conducted by the RBI shows that in the order of prominence, the following factors contribute to NPAs.
Internal Factors
• Diversion of funds for
-Expansion/diversification/modernization.
-Taking up new projects.
-Helping/promoting associate concerns.
• Time/cost overrun during the project
implementation.
• Inefficient management.
• Strained labour relations.
• Inappropriate technology/technical problems.
• Product obsolescence, etc.
• Poor credit Appraisals, monitoring and follow up,
improper SWOT analysis on the part of banks.
External Factors
• Recession.
• Input or power shortage.
• Price escalation.
• Exchange rate fluctuation.
• Accidents and natural calamities.
• Changes in government policy such as excise, import and export duties, pollution control order
etc.
• Willful defaulters have been there because they knew that legal recourse available to the lenders is time consuming and slow.
• Sickness of the industry also leads to gradual erosion of the liquidity and units start failing to honour its obligations for the loan payments. Heavy funds are locked up in these units.
• Political tool-Directed credit to SSI and Rural sectors has been there
• Manipulation by the debtors using political influence has been a cause for high industrial bad debts.
In the current perspective, the Economic Survey, 2012-13(paragraph 5.32) identifies the following as the “main” reasons for the growing NPAs:
a) Switchover to a system- based identification of NPAs by PSBs
b) prevailing macro-economic situation in the country;
c) Increased interest rates in the recent past;
d) Lower economic growth; and
e) Aggressive lending by banks in the past, especially during good times.
NPAs: Effect on the Performance of banks
The large percentages of NPAs have a deleterious impact on a bank’s profit in a number of ways:
• they result in reduced interest income
• They erode (eat into) current profits through provisioning requirements.
• it leads into erosion of capital base and reduction in their competitiveness
• Through creation of reserves and provisions that come from profits, to act as cushions for loan
losses.
• Decline in profit has its bearing on variables like Capital to Risk Weighted Assets Ratio (CRAR and cost).
To quote the committee on banking sector reforms (Narasimham Committee II, 1998) “NPAs constitute a real economic cost to the nation is that they reflect the application of scarce capital & credit funds to unproductive uses. The money locked up in NPAs is not available for productive uses to the extent that bank seek to make provisions for NPAs or write them off. It is a charge on their profits, NPAs, in short, is not just a problem for banks; they are bad for the economy”.
ANALYSIS ON NPAS
Non-performing assets are one of the important parameters of analyzing financial performance of banks.
This part of the paper focuses on trend analysis of NPAs and evaluates the financial health of commercial banks.
Gross NPAs and Net NPAs (as a percentage of advances and Total Assets)
Gross NPAs is an advance which is considered irrecoverable, for bank has made provisions, and which is still held in banks books of account.Net NPAs are obtained from gross NPAs after deduction of the following:
• Interest due but not received: i.e. balances in interest suspense account.
• Claims received from credit guarantors and kept in suspense accounts pending final settlement.
• Part payment received and kept in suspensions; and
• Total provisions held.
• Similarly gross advances consists of bills purchased and discounted, cash credits, overdrafts and loans and term loans, whereas net advance is calculated by netting out bills discounted, DICGC claims etc., from gross advances. Gross NPA is a better indicator than net NPAs since the former does not incorporate the endogenous provisioning process; this is because banks make provisioning for NPAs according to their capacities.Net NPAs does not present a true picture of NPAs so they will have to be supplemented by gross NPAs figures.
High level of NPAs in PSBs can be attributed to the following possible factors:
1. Various credits related welfare programs are carried out through public sector banks as they have a widespread network in the rural areas.
2. The problem of high gross NPAs is also one of inheritance. Historically, Indian public sector banks have been poor on credit recovery due to a weak legal provision governing foreclosure and bankruptcy, lengthy legal battles, sticky loans made to PSUs, loan waivers and priority sector lending.
3. PSBs also suffer due to lax system of granting advances, poor post-loan follow up and politically motivated policy framework. • All banks have been making efforts to contain the NPAs level and reduce the drag on their profitability. Even as individual banks devised various policies for containment of NPAs, the magnitude of the problem of slippage of performing assets to NPAs category has become a cause of permanent concern in the banks.
Impact of NPA
NPA impact the performance and profitability of banks. The most notable impact of NPA is change in banker’s sentiments which may hinder credit expansion to productive purpose.
Banks may incline towards more risk-free investments to avoid and reduce riskiness, which is not conducive for the growth of economy. If the level of NPAs is not controlled timely they will:
§ Reduce the earning capacity of assets and badly affect the ROI.
§ The cost of capital will go up.
§ The assets and liability mismatch will widen.
§ Higher provisioning requirement on mounting NPAs adversely affect capital adequacy ratio and banks profitability.
§ The economic value additions (EVA) by banks get upset because EVA is equal to the net operating profit minus cost of capital.
§ NPAs causes to decrease the value of share sometimes even below their book value in the capital market.
§ NPAs affect the risk facing ability of banks.
§ Reduce the earning capacity of assets and badly affect the ROI.
§ The cost of capital will go up.
§ The assets and liability mismatch will widen.
§ Higher provisioning requirement on mounting NPAs adversely affect capital adequacy ratio and banks profitability.
§ The economic value additions (EVA) by banks get upset because EVA is equal to the net operating profit minus cost of capital.
§ NPAs causes to decrease the value of share sometimes even below their book value in the capital market.
§ NPAs affect the risk facing ability of banks.
Conclusion
The SARFAESI Act has been largely perceived as facilitating asset recovery and reconstruction. Since Independence, the Government has adopted several ad-hoc measures to tackle sickness among financial institutions, foremost through nationalization of banks and relief measures. Over the course of time, the Government has put in place various mechanisms for cleaning the banking system from the menace of NPAs and revival of a healthy financial and banking sector. The Reserve Bank of India issued guidelines and directions relating to registration, measures of ARCs, functions of the company, prudential norms, acquisition of financial assets and related matters under the powers conferred by the SARFAESI Act, 2002.
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WEBSITES REFERRED:
- http://rbi.org.in
- http://iba.org.in