CHAPTER 10 Non-performing Assets : Important Points Commercial banks and other Financial Institutions in India lend money to entrepreneurs and others for generating interest income for itself as well as return of the principal amount lent. However, such lending is for future income generation which depends of uncertainties in performance, market demand and supply, and sometimes adverse economic conditions. This leads, sometimes, to a serious risk for lending institutions. Since 1992 when reforms started, Banks have been classifying these loan assets into various categories as per Reserve Bank of India s guidelines from time to time. The definition of performing and non-performing assets have been going around in the banking circles in different ways, till RBI standardized its definition as follows. DEFINITION A performing asset is one which yields regular income in terms of repayment of principal and interest. However, non-performing asset is one which has stopped yielding principal and/or interest and is not paid by the borrower for a period of 90 days. In simple words NPA is one in which following features occur. Installment of principal has remained past due for a specified period of time. On balance sheet date, account which shows following additional features is an NPA. Interest on a term loan account is past due. Cash credit/overdraft account remains out of order. Bill purchased/discounted is unpaid or overdue. Any amount to be received in respect of any other account remains past due for a period of more than 90 days. Related Definition of Terms (a) Out of Order Accounts Account is treated as out of order if outstanding balance remains continuously in excess of the sanctioned limit or drawing power. Also where outstanding balance in principal operating account is less than the sanctioned limit/drawing power, and the credits in the account continuously for 90 days are not enough to cover interest debited during the same period, such accounts are also treated as Out of Order Accounts. (b) Overdue Amount Any amount due to the bank on any credit facility is overdue if it is not paid on due date fixed by the bank.
166 Non-performing Assets: Important Points NARASIMHAM COMMITTEE RECOMMENDATIONS ON NPAS Purpose: The Committee recommended that banks should have greater consistency and transparency in their published accounts (balance sheet, profit & loss account). Norms have to be fixed for such transparency. RBI thus, initially fixed over 1 year (four quarters in case of Cooperative banks) as period of NPA to be defined. However, this period has been reduced in stages and at present it is 90 days. In the early stages of reforms and early guidelines of RBI, an asset was considered as NPA on the basis of past due concept. Asset becomes past due if it remains outstanding for 1 month (30 days) from the date it has become due. But in 31.3.2001 this concept was discarded and new concept was introduced based on period. Policy of income recognition: The Committee recommended that there should be objective and record based recovery classification. Simple accrual of interest posted as income in the books of accounts does not give transparency to the bank s performance. There, RBI directed banks from time to time to ensure that recovery should be considered on actual receipt basis and not on accrual basis. RBI, based on the recommendations of the Committee, directed banks to classify assets in different forms and for risks providing provisions. The basis for the provisioning are as follows: On the basis of the classification of assets. Based on the period for which the asset has remained NPA. Availability of security and the realizable value thereof. From 31.3.2004, RBI introduced a concept of out of order where an asset will be called an NPA, if principal and interest remain overdue or outstanding for a period of 90 days or more from the sanctioned limit or calculated drawing power in case of cash credit / overdraft accounts. Reasons of Slippages Most important slippage is poor / ineffective monitoring especially in big accounts having large amounts sanctioned, say over Rupees 10 lakh. Non-adherence to terms & conditions laid down in sanction letter, etc. Providing unjustified and continuous excesses / adhoc sanctions without proper appraisal of needs etc. Securities have become obsolete and have never or rarely been inspected. Bank fails to identify early warning signals at the right time and take remedial measures. Failure in due diligence (especially new / taken over accounts). Sometimes external factors lead to account becoming NPA like poor economic growth, demand and supply factors of the market, business failures, etc. Asset Classification As per Reserve Bank of India s guidelines banks classify their loan assets in FOUR groups. It has dispensed with the earlier classification based on eight Health Codes. The new classification is:
Non-performing Assets: Important Points 167 1. Standard Asset: Standard asset is one which does not show or indicate any sign of distress or problem with regard to recovery/repayment of dues. Normal banking risk (s) is/ are acceptable. Such assets are called Standard Assets. 2. Substandard Assets: With effect from March 31, 2001, a substandard asset was one, which has remained NPA for a period not exceeding 18 months. However this was reduced further in 31.3.2005 to 12 months by RBI. Now this period is 90 days from the due date. Characteristic critical features of such accounts are: Sub-standard asset has general credit weaknesses. It jeoparise the liquidation of debt. Bank may incur some In such cases, current net-worth of the borrower/guarantor or the current market value of the security charged to bank is not enough to ensure recovery. 3. Doubtful Assets: Starting from March 31, 2005, an asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months. Other important features of such assets are: Asset becomes NPA for more than 12 months ( which was 18 months before 31.05.2005). Liquidation of dues is highly doubtful or improbable or highly questionable. Security erosion at 50% or more over the previous year s value. 4. Loss Assets: A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. Though there may be some salvage. Other main features are: Loss identified by bank or by the internal auditor/ RBI or statutory auditors Amount not fully written off since there might be some salvage / recovery value, may be very small / negligible (less than even 10 % of outstanding) Some special aspects of NPA Security does not include net worth of the borrower or guarantor. If arrears of interest and principal are paid by the borrower in the case of loan accounts classified as NPAs, account may be classified as standard accounts. Gross and Net Non-performing Assets Simply speaking, Gross NPAs are the ones that show total figures of amount unrecovered without any adjustment of provisions etc. Net NPA = Gross NPA Provisions Provisioning Norms As per RBI guidelines, banks are required to provide provisions in their NPA accounts. Loss making Asset In case of loss making accounts, the provisioning shall be 100 per cent of the balance outstanding.
168 Non-performing Assets: Important Points Doubtful Asset In case of doubtful assets, banks are required to provide with 100 per cent for the portion of loan asset which is unsecured. However for secured portion of loan asset under doubtful category, if an asset remains in doubtful category up to 1 year, then provision shall be 20% of the balance outstanding and for 1 to 3 years, the provision shall be 30%. Slowly the amount of provision in doubtful category is increased to 100 per cent, increasing every year. Sub-Standard In case of sub-standard category of assets, a general provision of 10 per cent on the principal outstanding amount in the books is required. However, this 10% does not include guarantee receivable from Deposit Insurance & Credit Guarantee Corporation and Export Credit Guarantee Corporation. Provision for Standard Assets A general standard provision of 0.25% or as revised by RBI from time to time is applicable on all standard assets. LEGAL MEASURES OF LOAN RECOVERY Lok Adalats Lok adalat deals cases up to Rs.20.00 lacs Civil suits It is like a civil suit where attachment before Judgment takes place. It is suitable for cases as Summary suits where there is no security other than Demand Promissory Note Recovery through Revenue Recovery Acts as arrears of land revenue. Debt recovery Tribunal (DRT) Loans where outstanding of for more than Rs.10.00 lacs, DRT can be approached. Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SARFAESI) through attachment and sale of assets by Banks without intervention of court. This chapter has been discussed elsewhere in details. DEBT RECOVERY TRIBUNALS- IMPORTANT FEATURES OF THE ACT (Recovery of Debts due to banks and Financial Institutions Act- RDDB&FI Act) The establishment of Debt Recovery Tribunals for recovery of bank and financial institution dues was recommended by initially by Narasimham Committee followed by Tiwari Committee. The Act got the approval (assent) of the President of India on 27.8.1993. This Act was amended many times over the past 15 years. The period of amendments are given below: (i) The Recovery of Debts Due to banks and Financial Institutions (Amendment) Act, 1995 (28 of 1995). (ii) The Recovery of Debts Due to banks and Financial Institutions (Amendment) Act, 2000 (1 of 2000)
Non-performing Assets: Important Points 169 DRTs have been established mainly for providing a simple and summary procedure to banks for recovery of their dues in accordance with the principle of natural justice. It acts as a court of appeal for recovering of shortfall in dues which remain unpaid after exercising banks right under other laws like SARFAESI, 2002. Third advantage of establishing DRTs is to help banks seek recourse in it to recover unsecured dues of Rupees 10 lakh and above. Government of India has the powers to establish DRTs. It has the powers to establish one or more Debt Recovery Appellate Tribunals (DRAT) by notification. Composition of DRT: DRTs are having a small organizational structure with one Presiding Officer (PO), and one or more Recovery Officers beside by lean secretarial staff. Tenure of PO: The period for which Presiding Officer is appointed in DRT is for 5 years from the date on which he starts his office. Normally the Presiding Officer should be a person who qualifies to be District Judge. In case of DRAT, the Chairperson should qualify to be member of Indian Legal Service (experience minimum1-3 years),or Judge of High Court or Presiding Officer of DRT for 3 years. The Proceeding of DRT and DRAT are governed by (i) principle of natural justice, (ii) rules of civil procedure code (section 22 (2) of CPC, 1908). The jurisdiction of DRTs is not dependent on the location of charged property movable or immoveable, of defendant. Section 19(1) of RDDB & FI Act, 1993 provide that bank may file an application to the Tribunal where defendant resides at the time of making application or carry on business or where the cause of action, wholly or partly arise. Fees: Rule 7(1) and 7(2) of the RDDB & FI Act, 1993 lays down the procedure of filing application and fees to be deposited. The fee can be sent through crossed DD on a nationalized bank or through Indian Postal Order favouring Registrar. The fee structure is: If debt due is Rupees 10 lakh, fee is Rs.12,000/=. If debt is above Rs.10 lakh, fee is Rs.12,000/= plus Rs.1000/= for every Rs.1 lakh of debt or part thereof subject to maximum of Rs.1,50,000/= For review application, fee is 50% of fee paid.