Non Performing Assets (NPAs)

Some Important Facts

Business and Retail loan accounts(i.e. loan, cash credit, overdraft and bill
discounts - not related to agriculture) become non performing assets
(irregular/overdue/out of order) if Principal and/or Interest is not paid for a
continuous period of 90 days from the due date(that is, an overdue either in full
or in part, for a continuous period of 90 days).

The NPA guidelines issued by Reserve Bank classifies NPAs into three categories –
Sub Standard, Doubtful and Loss – on the basis of the length of time for which a
loan account has remained overdue and also on the basis of the probability of
recovery of the outstanding dues in that account. While normally a loan account
will pass through the three stages of Substandard, Doubtful and Loss, it is not
necessary that it ‘must’ pass through these three stages. For classifying an NPA,
the main consideration is not how long a loan account has remained in
Substandard category but the prospects of recovery of the loan. Therefore there
is no hard and first requirement that a “Sub Standard” loan has to remain in that
category for 12 months before getting downgraded to “Doubtful” category. In
fact, as the guidelines state, in certain circumstances, loan accounts remaining
irregular/overdue/out of order for a continuous period of 90 days, can be straight
away categorized as “Doubtful” or “Loss”, without keeping it in “Substandard”
category for 12 months.

If the value of the security taken against a loan falls below 50% of the value that
was assessed during the last valuation, that loan is to be straight away classified
as Doubtful even if it has not completed 12 months as NPA. For example, if the
value of a security in an NPA account was found to be Rs 80 lakhs in April 2010
and during the inspection in June 2010 the realizable value of that security is
found to be Rs 35 lakhs only, the Substandard account has to be straightaway
classified as Doubtful asset.

Similarly, where the realizable value of a security taken against a loan is less than
10% of the outstanding amount in the borrowal account, the existence of that
security should be ignored and that loan account should be straightaway
classified as Loss asset.
Provisions

NPAs hit the banks hard in two ways. First, banks are not permitted to
charge(collect) interest in such accounts. In addition to this loss of income, banks
are required to make provisions to meet the loss, in case they are not able to
recover the amount over a period of time. Provision is an amount set aside, for
meeting future losses.

For example, if a loan with a balance of Rs 10 lakhs becomes NPA, the loss to the
bank in that year will be :

(a)Loss of interest income, say @ 12% i.e. Rs 1.2 lakhs

(b)Provision, say@ 10% of balance outstanding Rs 1.0 lakh
(c)Total Loss in that year Rs 2.2 lakhs

And this loss does not stop at that level. The loss will increase year after year due
to increases with worsening classification from substandard to doubtful to loss ,
since the rate of provision increases with deterioration in the asset status.

The provisions required to be made on NPA accounts are as follows :

Accounts Provisioning
Standard 0.25% on direct loans to agricultural & SME
sector

1% on residential housing loans in excess of

Rs20 lakhs

2% on personal loans, commercial real estate

loans, loans to NBFCs & capital market
exposures

0.40% on all other loans & advances

Substandard 10% of the amount outstanding without any
allowance for ECGC cover and/or other
security
D1 – Doubtful < 12 months 20% of secured portion + 100% of unsecured
portion
D2 – Doubtful > 12 months, upto 30% of secured portion + 100% of unsecured
36 months portion
D3 – Doubtful > 36 months 100% of exposure
Loss 100% of exposure

RBI has mandated banks to make provisions on Standard assets also, so as to

strengthen the financial position of banks and enable them to meet any
unforeseen credit losses in the future. Some banks make “floating provisions”,
over and above the provisions mandated by RBI, as a measure of abundant
caution.

Early warning signals: These are signs of weakness of businesses and early
indications of a loan account going bad. Banks who track these signals and take
corrective steps early, avoid NPAs to a good extent. They are as under:

Return of cheques issued by the borrower-customer.

Return of cheques deposited by the borrower-customer

Frequently depositing cash to prevent return of cheques.

Frequent requests for overdrawing or adhoc(temporary) increase in limits.

Delays in payment of instalments in term loan account.

Return of bills or delay in payment of bills drawn by the customer.

Delay on the part of the borrower-customer in payment of bills drawn on them by

their suppliers.

Non payment of LCs in time.

Devolvement of guarantees.
Utilisation of working capital limits to the full extent continuously.

Decrease in transactions or credit summations in the cash

credit/overdraft/current accounts.

Fall in sales, fall in profitability, disproportionate increase in current assets, fall in

sundry creditors and other such indications of declining financial health.

Diversion of working capital funds for acquiring fixed assets or other investments.

Siphoning off funds for non-business purpose.

Delay in submission of statements of Stock, Book debt, QIS and other such
operational statements.

Resignations by members of the senior management team.

Frequent change in persons manning key positions such as CFO, Marketing Head,
Production Head etc.

Frequent labour unrest.

Loss of customers and increasing reliance on a few customers.

Unfavourable market reports/rumours

Continuous decline in the price of the shares of the company in stock market.

Enquiries being received from other banks, finance companies etc on the financial
status of the borrower-company. This indicates that the company is attempting to
borrow money from other sources without informing its bank.

Legal action initiated against the company for quality disputes or for non-payment
of dues to its creditors.

Reluctance of the borrower to meet bank officials or take phone calls.

Requests by the gurantors to be released from the guarantee.

Development of new technology that could affect the competitiveness of the

customer.

Imposition of duties/taxex by the government which could affect the customer

adversely.

Impact of NPAs :

a. NPAs do not generate income

b. They require provisions
c. Borrowing cost of resources locked in NPAs ; reduction in lending rate is
made difficult
d. Recycling of funds get blocked
e. Enhances administrative, legal and recovery costs
f. Reduces profitability substantially
g. Impairs the reputation of banks and decreases their capacity to raise
resources from markets
h. Affects the morale of employees , decreases their risk-taking ability ,
decision making for fresh loans suffer – all this ultimately affects the
competitiveness of the bank.

Reasons for arising of NPAs :

Borrower Specific reasons

a. Management inefficiency
b. Diversion of funds and misutilisation of funds (Wilful defaults)
c. Faulty project planning, resulting in time / cost over run
d. Wrong or obsolete technology
e. Product failing to capture the market
f. Product obsolence
g. Strained labour relations

External reasons on which borrower has no control

 a. Shortage of raw materials
b. Power shortage
c. Price escalation
d. Excess capacities
e. Monsoon dependency
f. Natural calamities
g. Social unrest
h. General economic recession
i. Government policies

Bank specific reasons

a. Too many eggs in one basket (i.e. sectoral concentration)

b. Inadequate credit appraisal
c. Delayed credit decisions
d. Wrong selection of clients
e. Competition among banks
f. Absence of legally enforceable and recoverable security
g. Incomplete documentation
h. Non renewal of documents in time
i. Failure to recognize the early warning signals

Strategies of Banks for Containment / Management of NPAs:

These strategies are three-fold – Preventive, Detective & Corrective.

Preventive

a. Lay down bank’s policy on management and recovery of NPAs

b. Stress on proactive initiatives to prevent fresh NPAs by prescribing time
norms for detection of early warning signals for taking remedial actions
c. Effective market intelligence
d. Periodic dialogue with the borrower/s
e. Stringent scrutiny of financial statements
f. Control over excess drawings/overdrafts
g. Periodical valuation of securities
h. Continuous watch over the management of borrowing company/ies
 i. Putting in place a system to identify borderline NPAs and monitoring their
migration
j. Continuous vigil over the conduct of accounts
k. Compliance of pending audit/inspection irregularities
l. Unit inspection both at pre and post sanction stages ;
surprise/unannounced inspection of units.

Detective

a. Look for pressure on the accounts

b. Unauthorised excesses
c. Turnover increasing / decreasing
d. Hardcore borrowing appearing on current accounts
e. Unpaid cheques – in or out
f. Frequent requests by the borrower for increase in facilities
g. Idle / slow moving current assets(effect on capital employed)
h. Hardcore increase in average debit balance
i. Delays in realization of bills receivables

Corrective

a. Discuss the problems with the borrower to findout if there are wayouts
which the bank can address
b. Collect as much information as possible about the unit discreetly
c. Carryout a SWOT analysis of the account/company
d. Visit business premises and check the securities and examine whether
additional will be available
Set objectives for the way forward(road map), investigate as to what went
e. wrong with the original proposal of the borrower and as to where his
calculation and actions have gone wrong
f. Obtain borrower’s understanding of, and commitment to, any plan of
repayment - particularly timing and and amounts and get agreements in
writing then and there, if possible
g. Take firm control of the position. If commitments are not met, take speedy
and firm action

Compromise and One Time Settlement :

Negotiation

a. Know your NPAs

b. Know the history of the company and the conduct of its account
c. Know well the reasons for the loan going bad
d. Do not try to knock off a settlement in one sitting
e. Finalise the compromise amount
f. Look forward to the borrower fulfilling commitment

If the negotiation and compromise resolutions fail, then the only option left with
is legal action. Proceed legally to ensure quickest recovery (Debt Recovery
Tribunal , SARFAESI Act).

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