ASIAN JOURNAL OF MANAGEMENT RESEARCH Online Open Access publishing platform for Management Research

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1 ASIAN JOURNAL OF MANAGEMENT RESEARCH Online Open Access publishing platform for Management Research Copyright 2010 All rights reserved Integrated Publishing association Review Article ISSN Non performing assets: Issues, Causes and remedial Solution Poongavanam.S H.O.D., Department of Management studies, Ranippettai Engineering College, Thenkaddapanthangal, Walaja Taluk, Vellore District Tamil Nadu. ABSTRACT The banking industry has undergone a sea change after the first phase of economic liberalization in 1991 and hence credit management. While the primary function of banks is to lend funds as loans to various sectors such as agriculture, industry, personal loans, housing loans etc., in recent times the banks have become very cautious in extending loans, this is due to mounting nonperforming assets (NPAs). Therefore, an NPA account not only reduces profitability of banks by provisioning in the profit and loss account, but their carrying cost is also increased which results in excess & avoidable management attention. Apart from this, a high level of NPA also puts strain on a banks net worth because banks are under pressure to maintain a desired level of Capital Adequacy and in the absence of comfortable profit level, banks eventually look towards their internal financial strength to fulfill the norms thereby slowly eroding the net worth. Considering all the above facts banking industry has to give more importance to NPA and to structure proper remedial solutions. Key words: Assets restructuring company, Global competition, Rate of return, Repayment schedule, Lok Adalats. 1. Introduction After Nationalization the initial mandate that bank were given was to expand their branch network, increase the saving rate and extent credit to rural and SSI sector.(talwar, 2001) Since 1990 the focus was sifter towards improving the quality of assets and better risk management. In August 1991, a high level committee headed by Mr.M.Narasimhan was appointed to examine various aspects of the financial system. One of the important recommendations is balance sheets of the banks should be transparent and comply with international accounting standards. (Vasanthi, 2006)The Committee recommended that banks should adopt uniform accounting practices in regard to income recognition and bad debt provisioning. Income recognition of nonperforming assets should not be on accrual basis but on record of recovery.the committee also recommended that provisioning should depend upon a proper classification of assets, which in turn should be based on objective criteria. Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines issued by RBI. ( ASIAN JOURNAL OF MANAGEMENT RESEARCH 123

2 An amount due under any credit facility is treated as "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 (give out) with 'past due' concept, with effect from March 31, Accordingly, as from that date, a Non performing asset (NPA) shell be an advance where - 1. interest and /or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan, 2. the account remains 'out of order' for a period of more than 180 days, in respect of an overdraft/ cash Credit(OD/CC), 3. the bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted, 4. 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 5. any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.( 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, Accordingly, with effect form March 31, 2004, a non-performing asset (NPA) shell be a loan or an advance where; 1. interest and /or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan, 2. the account remains 'out of order' for a period of more than 90 days, in respect of an overdraft/ cash Credit(OD/CC), 3. the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, 4. 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 5. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts. In case of agriculture advance 1. a loan granted to a short duration crop will be treated as NPA, if the installment or interest thereon remains overdue for two crop seasons. 2. a loan granted for long duration(crop season longer than one years) crops will be treated as NPA, if the installment/interest remain unpaid for one crop season ASIAN JOURNAL OF MANAGEMENT RESEARCH 124

3 2. Provisioning requirements Non performing assets: Issues, Causes and remedial Solution Table 1: Assets Category & Provision Requirement Asset Category Provision Required Substandard Assets Provision of 10% of the outstanding (denoted as code 21) -Secured Provision of 20% of the outstanding (denoted as code 22) -Unsecured Doubtful Assets -Doubtful I -Doubtful II Provision of 20% of realizable value of security plus 100% of the shortfall of security(denoted by code 31) Provision of 30% of realizable value of security plus 100% of the shortfall of security(denoted by code 32) -Doubtful III Provision of 100% (denoted by code 33) Loss Assets Provision of 100% (denoted by code 41) Sources: 3. Reasons for an asset turning NPA Various Studies have been conducted to analyze the reasons for NPA, what ever may be complete elimination of NPA is impossible. The reason were generally classified into two 1. Overhand component due to environmental reasons, business cycle etc 2. Incremental component due to internal bank management, credit policy, term of credit etc. There are various reasons either jointly or singly responsible for an asset becoming NPA can be classified as follows:- 3.1 Reasons from the economic side 1. Political: Mindset regarding paradigm, proactive, fiscal responsible, major portion of NPA arise out of lending to priority sector at the dictates of politicians and bureaucrats. 2. Economic: Growth, distribution, efficient allocation of resource. 3. Social: Acceptability, mobility, education. 4. Technological: Lack of adoption of IT makes data processing difficult. 5. Legal: loan contracts are not enforceable naturally be a tendency to default. ASIAN JOURNAL OF MANAGEMENT RESEARCH 125

4 6. Environmental: Liberalization and globalization. 3.2 Reasons from the industry side 1. Global competition. 2. Cyclical downswing. 3. Sunset industry industry growing slowly or declining. 4. Frequent changes in regulatory norms. 3.3 Reasons from the borrower side 1. Misconceived project. 2. Poor governance. 3. Product failure. 4. Bungling management. 5. Diversion of fund. 6. Dormant capital structure. 7. Regulator changes. 3.4 Reasons from the banking side 1. Parameter set for functioning was deficient. 2. Lack of freedom to choose product and pricing. 3. Unexposed to international marketing methods and products. 4. Wrong lending decision. 5. Lack of Resource and poor training. 6. Lack of system and procedure. 7. Lack of ability to handle assets and liability. 8. Lack of mechanism of credit information dissemination. 9. Lack of an effective judicial system for recovery from defaulters. 10. Collateral based lending to idle assets. 11. Fixing of price and quantum of loans. 12. Lack of effective IT system and MIS. 3.5 Reasons from the loan structuring side 1. High debt equity ratio. 2. Timing of raising equity. ASIAN JOURNAL OF MANAGEMENT RESEARCH 126

5 3. Discrepancy between rate of interest charged and realistic rate of return. 4. Inconsistency between revenue generation and the loan repayment schedule. 5. Lack of binding penal clause and performance guarantees. 6. Rising interest rate. 3.6 Reason from the security side There is a tendency among bank and institution to depend excessively on collateral for advancing loans. It is important to presume that if the borrower default in repaying then the security given will be helpful for recovery of loan. Clearly this logic is unacceptable. Emphasis should be on cash generation and a charge on this should be built into the loan contract through some escrow mechanism. 3.7 Reason from the regulatory side Frequently regulator changes can turn assets non performing. Accounting reason like reduction in income recognition norms from 180 days to 90 days could be one reason and political related issues could be the other reason. Table 2: NPA Causes and Mechanism to solve the problems - in different country Country Causes of problem Mechanism to solve the problem India Legal impediment and time consuming nature of asset disposals process. Manipulation of debtors using political influence. Political toll directed credit to SSI and rural sector. Strengthening the legal procedure. Aligning the prudential standards with international standard. Legal mechanism including the China Japan Moral hazard. Bankruptcy law favours borrower. Political and social implication. Inefficient legal enforcement mechanism. Real estate boom and bust. Time consuming legal mechanism. No bankruptcy doctrine. creation of ARC. Creation of assets management. Foreign equity contribution in NPA disposal process. Raising disclosure standard. Law enabling assets backed securitization. Strict action for non compliance of capital norms. Securitization of real estate loans. Korea Directed credit- interest rate control. Lack of effective monitoring. Compressed growth policy. Reducing the systematic risk. Creating Korea assets management corporation. Use of corporate restructuring vehicle and debt equity swaps. ASIAN JOURNAL OF MANAGEMENT RESEARCH 127

6 Thailand Legal system is favourable to debtors. Steep interest rate increase. Liberalized capitals account and current account. Real estate speculation Sources :Prashanth K Reddy, 2002 Privatization of Government entities. Government takes over of banks and FIs. Removal of caps on foreign equity. Creation of AMS. 4. Solutions 4.1 Restructuring of finance Bank has to increases the number of installment by minimizing the quantum of installment in order to recover the loan. 4.2 Industrial Reconstruction Bank of India (IRBI) IRBI was set up on 20 th March 1985, by reconstituting the Industrial reconstruction corporation of India as the principal credit and reconstruction agency for industrial revival and to coordinate similar work of the other institution engaged there in and to assist and promote industrial development and to rehabilitate industrial concern. 4.3 ARCs ARCs purchase bad or non-performing loans, either of a company or an entire portfolio, hoping to restructure the loan or sell the assets to make money. Similarly Danaharata was established in Malaysia, Kamco in Korea and PT in Indonesia. Concerns have been raised about their relevance to India. (Viswanathan, 2002) 4.4 Lok Adalats Lender and borrowers were brought face to face to negotiate a settlement. 4.5 Debt Recovery Tribunal It was set up under the recovery of debts due to banks and Financial Intuitions Act, 1993 with exclusive jurisdiction to try and dispose of matters pertaining to recovery of debts due to bank and financial assets. It has the potential of playing a significant role in NPA realization. 4.6 Corporate debt restructuring Corporate debt restructuring mechanism was introduced as a platform for handling large NPA, with a potential to give long term package of financial and management restructuring. It rephases the loan servicing obligation of the borrower and some concession in the interest rate. ASIAN JOURNAL OF MANAGEMENT RESEARCH 128

7 4.7 SARFAEST Act SAREAEST is the preferred route for finding solution to NPA when compared to the other methods which were discussed above. There was no legal provision for facilitating securitization of financial assets of bank and FIs or power to take possession of securities and sell them. This resulted in slow recovery of defaulting loan and mounting levels of NPA of bank and FIs and a need was felt for keeping pace with changing commercial practice and financial sector reforms. (Toshiki, Kanomori, 2001) Keeping with this an enabling legislative and regulatory frame work was put in place with the enactment of the securitization and Reconstruction of Financial assets and Enforcement of Security interest Act,2002.The primary objective of act is reduction of NPA levels of banks/fis and unlocking value from distressed assets in the banking and financial system. 4.8 Well Developed Capital Markets Numerous papers have stressed the criticality of a well developed capital market in the restructuring process. A capital market brings liquidity and a mechanism for write off of loans. Without this a bank may seek to postpone the NPA problem for fear of capital adequacy problems and resort to tactics like ever greening. Monitoring by bondholders is better as they have no motive to sustain uneconomic activity. Further, the banks can manage credit risk better as it is easier to sell or securitize loans and negotiate credit derivatives. India debt market is relatively under developed and attention should be focused on building liquidity and volumes. (Toshiki, Kanomori, 2001) 4.9 Contextual Decision making Regulations must incorporate a contextual perspective (like temporary cash flow problems) and clients should be handled in a manner which reflects true value of their assets and future potential to pay. The top management should delegate authority and back the decisions of this kind taken by middle level managers Legal Issues There have been instances of banks extending credit to doubtful debtors (who willfully 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 authorizing officer are punished heavily. Without this, all the mechanisms suggested above may prove to be ineffective. (Muniappan, 2002) 4.11 Regular Training Program Executives have to undergo regular training program on credit and NPA management. It is very useful and helpful to the executives for dealing the NPAs properly Recovery camps The banks should conduct regular or periodical recovery camps in the bank premises or some other place, such type of recovery camps reduced the levels of NPA in the banks ASIAN JOURNAL OF MANAGEMENT RESEARCH 129

8 4.13 Spot Visit The bank officials should visit to the borrower s business place / borrowers field regularly or periodically Other Methods 5. Conclusion 1. Persistent phone calls. 2. Media announcement. Banking industry has undergone a major change after the first phase of economic liberalization; hence the importance credit management has emerged. In recent time banks are very cautious in extending loan, because of mounting NPA. This article highlights the reasons for an assets becoming NPA and remedial measures to be taken. Due to various steps taken by the Government of India NPA levels were reduced to considerable level. (Nearly 2.7% of the loans on the balance sheet of bank, from 8.8%) So it is an indication for the bankers with bad loan in their portfolio to take appropriate actions immediately. 6. References 1. Jansen, D & Baye, M (1999), Money, Banking & Financial Markets An Economics Approach, AITBS Publishers and Distributors, New Delhi. 2. Mohan, R (2003), Transforming Indian Banking In search of a better tomorrow, Reserve Bank of India Bulletin. 3. McGoven, J (1998), Why Bad Loans happen to Good Banks, The Journal Of Commercial Lending, Philadelphia, Muniappan, G (2002): The NPA Overhang Magnitude, Solution and Legal Reforms, Reserve Bank of India Bulletin, May. 5. Rajaraman, I & Vashistha, G (2002), Non-Performing Loans of Indian Public Sector Banks Some Panel Results, Economic & Political Weekly. 6. Bloem, A.M., & Goerter, C.N (2001), The Macroeconomic Statistical Treatment of Non-Performing loans, Discussion Paper, Statistics Department of the IMF. 7. Reserve Bank of India. (1999), Some Aspects and Issues Relating to NPAs in Commercial Banks, RBI Bulletin. 8. Woo, David, (2000), Two Approaches to Resolving Non performing Assets During Financial Crises, IM Working Paper, WP/OO/33. ASIAN JOURNAL OF MANAGEMENT RESEARCH 130

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10 24. Rajaraman, I & Vashistha, G. (2002), Non-Performing Loans of Indian Public Sector Banks Some Panel Results, Economic & Political Weekly. 25. Prashanth K Reddy (2002), A Comparative Study of Non-performing Assets in India in the Global Context-Similarities and dissimilarities, remedial measures, The Indian Institute of Management, Ahmedabad, India 26. Toshibi, Kanamori (2002), China Economy and financial market after the WTO, China and world Economy. 27 Muniappan, G. P (2002), Indian Banking: Paradigm Shift, A regulatory point address of the Bank Economist Conference, Kolkata, accessed during September accessed during September 2011 ASIAN JOURNAL OF MANAGEMENT RESEARCH 132