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									                          EXECUTIVE SUMMARY
        The Non-Performing Assets (NPAs) problem is one of the foremost and
the most formidable problems that have shaken the entire banking industry in
India like an earthquake. Like a canker worm, it has been eating the banking
system from within, since long. And like the dreaded disease AIDS, banks have
not been able to find a reliable cure for this malady. It has grown like a cancer
and has infected every limb of the banking system.

        At the macro level, NPAs have chocked off the supply line of credit to the
potential borrowers, thereby having a deleterious effect on capital formation and
arresting the economic activity in the country. At the micro level, the
unsustainable level of NPAs has eroded the profitability of banks through
reduced interest income and provisioning requirements, besides restricting the
recycling of funds leading to serious asset-liability mismatches. It has inter alia
lead to reduction in their competitiveness and erosion in their capital base as
well.

        The problem of NPAs is not a matter of concern for the lenders alone. It is
a matter of grave concern to the public as well, as bank credit is the catalyst to
the economic growth of the country and any bottleneck in the smooth flow of
credit, one cause for which is mounting NPAs, is bound to create adverse
repercussions in the economy. Mounting menace of NPAs has raised the cost of
credit, made banks more averse to risk and squeezed genuine small and
medium enterprises from accessing competitive credit and has throttled their
enterprising spirits as well.

        The spiraling and the devastating affect of NPAs on the economy have
made the problem of NPAs an issue of public debate and of national priority.
Therefore, any measure or reform on this front would be inadequate and
incomprehensive, if it fails to make a dent in NPAs' reduction and stall their
growth in future, as well.




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          TABLE OF CONTENTS



Sr.             NAME                 PAGE
No.                                   No.
 1.       Introduction to NPAs        01
 2.        NPA Classification         04
 3.        Valuation of NPAs          08
 4.   Factors responsible for NPAs    13
 5.             Statistics            16

6.        Implication of NPAs         20
      Committee on Banking Sector
7.                                    22
                Reforms
 8.    Measures to Recover NPAs       25
 9.        Securatisation Act         41
10.      Management of NPAs           50
11.           Conclusion              52
             Bibliography             53
   INTRODUCTION TO NPAs

       Granting of credit facilities for economic activities is the main raison d’etre
of banking. Apart from raising resources through fresh deposits, borrowings, etc.
recycling of funds received back from borrowers constitutes a major part of
funding credit dispensation activities. Non-recovery of installments as also
interest on the loan portfolio negates the effectiveness of this process of the
credit cycle. Non-recovery also affects the profitability of banks besides being
required to maintain more owned funds by way of capital and creation of
reserves and provisions to act as cushion for the loan losses. Avoidance of loan
losses is one of the pre-occupations of management of banks. While complete
elimination of such losses is not possible, bank managements aim to keep the
losses at a low level. In fact, it is the level of non-performing advances, which, to
a great extent, differentiates between a good and a bad bank. Mounting NPAs
may also have more widespread repercussions. To avoid shock waves affecting
the system, the salvaging exercise is done by the Government or by the industry
on the behest of Government/ central bank of the country putting pressure on the
exchequer.


       In India, the NPAs, which are considered to be at higher levels than those
in other countries, have, of late, attracted the attention of public as also of
international financial institutions. This has gained further prominence in the
wake of transparency and disclosure measures initiated by the RBI during recent
years. The Committee on Financial System, Capital Account Convertibility
Committee on Non-Performing Assets of Public Sector Banks has dealt with the
subject of NPAs of Indian banks.




                                                                                    6
What is an NPA?


       To begin with, it seems appropriate to define Non-Performing Advance
popularly called NPA. Non-Performing Advance is defined as an advance where
payment of interest or repayment of installment of principal (in case of Term
Loans) or both remains unpaid for a period of two quarters or more. However
with effect from March 2004, default status would be given to a borrower if dues
were not paid for 90 days. If any advance or credit facilities granted by bank to a
borrower becomes non-performing, then the bank will have to treat all the
advances/credit facilities granted to that borrower as non-performing without
having any regard to the fact that there may still exist certain advances / credit
facilities having performing status.

The magnitude
       The NPAs in the Indian banking system have assumed astronomical
dimensions. NPAs of scheduled commercial banks totaled Rs.70,904 cr as on
March 31, 2002, which form 10.40% of our gross bank credit, about 15.75% of
our annual budget and 3% of our Gross Domestic Product. It is equivalent to our
annual defense budget. In absolute terms, NPAs have been increasing at the
rate of about 5 to 6% every year. The staggering magnitude of NPAs is costing
the public sector banks alone, more than Rs. 5,000 cr annually, by way of loss of
interest income, apart from servicing and litigation costs. The malady of high
level of NPAs eroding the profitability of banks is not confined to public sector
banks alone, it is equally hammering the bottom lines of old as well as new
generation private sector banks and foreign banks.

Segmentation of NPAs


       NPAs cover a cross-section of industries such as iron and steel and
related units like Ferro Alloys; Manmade textiles; Real estate / Civil and Project
related construction; Pharmaceutical; Leather / goods export; Garment export;



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Fertilizers and Chemicals; Cement and Cotton (fibres / textiles); Tea / Coffee;
Jute; Sugar; and Jewellery / Diamonds.


NPA in Indian Banks Vis-à-Vis other countries


         Comparison of the problem loan levels in Indian banking system vis-à-vis
those in other countries, particularly those in developed economies, is often
made, more so in the context of the opening up of our financial sector. The data
in respect of NPAs level of banking system available for countries USA, Japan,
Hong Kong, Korea, Taiwan and Malaysia reveal that to ranges from 1% to 8.1%
during 1993-94, 0.9% to 5.5% during 1994-95 and 0.85% to 3.9% during 1995-96
as against 23.6% 19.5% and 17.3% respectively for Indian banks during these
years.


         Notwithstanding   this,   some    features    relating   to   the    NPA
reporting/evaluation practices in other countries vis-à-vis those in our countries
need, however, to be considered before reaching to any conclusion on the level
of NPAs. In some countries, all or bulk of banks’ provisions are general
provisions and identified losses are written –off at an early stage. Banks in these
countries carry very little NPAs in their balance sheets. The recovery measures
are also very expeditious in view of stringent bankruptcy and foreclosure laws.
The concept of gross NPA and Net NPA is not in vogue in these countries. In
Indian banking, due to time lag involved in recovery process and the detailed
safeguards/procedures involved before write-offs could be affected, banks even
after making provisions for the advances considered irrecoverable, continue to
hold such advances in their books which is termed as Gross NPA together with
the provisions. The provision adjusted NPAs in Indian banking segment i.e. Net
NPAs, constitute only 8.2% of the net advances of the banks as on 31 st March,
1998 which no doubt are high by international standard but are not so alarming
as Gross NPAs project.




                                                                                 8
                         NPA CLASSIFICATION


NPA Norms across the world:


       The details and classification standards of non-performance vary from
country to country, as the countries put in place norms as per the
peculiarities/requirements of their banking systems.


       The practices with regard to these securities also differ. In certain
countries, an advance is considered ‘un-collectible’ and classified as ‘loss’ asset
only after it remains as past due or doubtful for a certain length of time, whereas
in India, an advance is considered to be classified as ‘loss’ the moment it is
considered ‘un-collectible’. In certain other countries, the available securities are
deducted from the doubtful advance to arrive at the net doubtful portion, whereas
in India provision is required to be made even on the secured portion. In India,
the provision required to be made in respect of the portion not covered by the
realizable value of securities in ‘doubtful’ advance 100% whereas in some
countries, it’s 75% or even 50%. The concept of ‘collateral’ also differs in as
much as security of standby nature like guarantee of promoter/third party, net
worth of the promoter/guarantor are not considered as security in India.


Historical Conceptualization of Problem Loans in Indian Banking:


Health Code System:


       A critical analysis of a comprehensive and uniform credit monitoring was
introduced in 1985-86 by RBI by way of the Health Code System in banks, which
inter alia, provided information regarding the health of individual advances, the
quality of credit portfolio and extent of advances causing in relation to total
advances. It was considered that such information would be of immense use to
bank managements for control purposes. The RBI advised all commercial banks



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(excluding foreign banks, most of which had similar coding system in their
organizations) on November 7, 1985 to introduce the Health Code classification
indicating the quality (or health) of individual advances in the following eight
categories, with a health code assigned to each borrowal account:


1.Satisfactory              Conduct is satisfactory; all terms and conditions are
                            complied with; all accounts are in order; and safety
                            of the account is not in doubt.
2.Irregular                 The safety of the advance is not suspected, though
                            there may be occasional irregularities which may be
                            considered to be as a short term phenomenon
3. Sick-viable              Advances to unit which are sick but viable under
                            nursing and units in respect of which nursing/revival
                            programmes are taken up
4.Sick: non-viable/sticky   The irregularities continue to persist and there are no
                            immediate prospects of regularization; the accounts
                            could throw up some of the usual signs of incipient
                            sickness
5.Advances recalled         Accounts where the repayment is highly doubtful and
                            nursing is not considered worthwhile; includes where
                            decisions have been taken to recall the advance
6.Suit filed accounts       Accounts    where     legal   actions   or    recovery
                            proceedings have been initiated
7.Decreed debts             Where decrees have been obtained
8. Bad and doubtful debts   Where the recoverability of the banks’ dues has
                            become doubtful on account of short-fall in value of
                            security; difficulty in enforcing and realizing the
                            securities; or inability/unwillingness of the borrowers
                            to repay the banks’ dues partly or wholly
Under the above Health Code System, the RBI was classifying problem loans of
each bank in three categories, which are as under:



                                                                                10
              (a) Advances       classified    as      bad    and   doubtful by the       bank
                     (corresponding to Health Code No. 8)
              (b) Advances          where      suits        were    filed/decrees     obtained
                     (corresponding to Health Codes Nos. 6 & 7) and
              (c)    Those advances with major undesirable features (broadly
                     corresponding to Health Codes Nos. 4 & 5)


PRUDENTIAL NORMS


          In order to ensure greater transparency in the borrowal accounts and to
reflect actual health of banks in their Balance Sheets, RBI introduced prudential
regulations relating to –


Asset Classification – An Asset is considered “Non Performing” in case if interest
or installments of principal or both remain unpaid for more than two quarters and
if   it   has       become   past     due,    i.e.,    30    days   after   the     due   date.
An Advance is to be classified as “Sub-standard” if it remains NPA upto a period
of two years and will be classified as “Doubtful” if it remains NPA for more than
eighteen months.


An account will be classified as “Loss”, without any waiting period, where the
dues       are      considered      uncollectible      or    only    marginally     collectible.


BASIS OF NPAs


          The basis of treating a credit facility as NPA is as detailed below:


ASSET In respect of which interest has remained past due for six months.
TERM LOAN Inclusive of unpaid interest, when the installment is overdue for
more than six months/on which interest amount remained past due for six
months.




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BILL Which remains overdue for six months.


OTHER CURRENT ASSETS The interest in respect of a debt/income on a
receivable in the nature of short-term loans/ advances, which remained overdue
for a period of six months.


SALE    OF    ASSETS/SERVICE        RENDERED.    Any dues on      account   of
these/reimbursement of expenses rendered which remained overdue for a period
of six months.


LEASE RENTAL/HIRE-PURCHASE INSTALMENT The installment which has
become overdue for a period of more than twelve months.


OTHER CREDIT FACILITIES The balance outstanding including interest
accrued made available to the borrower/beneficiary in the same capacity when
any of the credit facilities become NPA.




                                                                            12
       VALUATION OF NPAS: DIFFERING APPROACHES

        NPAs are a by-product of most financial systems and the level of NPAs is
an indicator of the health of the financial system of an economy. Valuation
techniques should present the situation, which maximizes the overall interests of
all the concerned parties.
The broad objectives of the valuation Framework are essentially:


       To set a sound basis for the selling bank/ institution to finalize the sale of
        assets,
       To provide a basis for the fair market value of the assets,
       To promote transparency of the valuation processes, and,
       To comply with internationally accepted practices.


The valuation of an asset or the pool of assets is a precursor to any restructuring
exercise. Any valuation exercise shall attempt to address the following issues:


       The fair market value of the asset should represent the price at which
        market participants would undertake a restructuring.
       The transaction value should reflect the potential for income generation
        and return of principal, balanced against the applicable risk profile and
        market lending margins.
       The valuation Framework should allow for valuation of specific assets as
        well as a portfolio of assets (i.e. portfolio of loans to be acquired from a
        bank). In most cases, a single value will apply to each loan acquired. For
        larger loans, however, an element of risk/return sharing with the selling
        bank may be considered.


I shall now discuss here the valuation approach in two parts i.e. (i) traditional
approaches and (ii) unconventional approaches.
Traditional Schools of Valuation Processes



                                                                                   13
       There are various methodologies used to value the companies or their
debt. Typically cash flows, assets or replacement values, or a combination of
these, are considered when determining the value of a company or its debt. The
matrix shows the risk profile of the NPA based on its cash flows and collateral.
As shown, stronger the cash flows and collateral, lower the risk profile of the
asset. Some of the widely used approaches towards valuation of an NPA by the
valuation firms are detailed as under:


      Discounted cash flows
      Liquidation / sale of assets
      Earnings model
      Case specific valuation models


Discounted cash flows


       One of the commonly used methods for estimating the value of the
company’s debt is the anticipated cash flows. The cash flow stream will represent
the interest and principal payments expected to be received by the lender,
primarily arising out of the internal cash flow generation from underlying business
activities. Where the asset is a partly completed project, the cash flow stream will
have to take into account whether the project will be completed and if so how it
will be financed. If certain lenders decide to fund this through extended facility,
this will be taken into account in the asset's cash flow stream. Essentially the
decision on the project’s financial viability will be determined by using an
incremental cash flow analysis. Normally, the value of a healthy asset is
computed as the discounted value of the expected future cash flows. However, a
company in distress or an NPA may have negative earnings (profit before
interest, depreciation and tax) and may be likely to incur operating losses for the
next few years. For such companies, the estimation of future cash flows is not so
easy, as there is a strong possibility of bankruptcy (Damodaran, 1994). Under
such a scenario the asset valuation is also based on subjective parameters. A


                                                                                 14
company under financial distress has some or all of the following characteristics:
operating loss, inability to meet the debt obligations and high debt equity ratio.
When dealing with such cases, the credit analysts need to evaluate the
possibility and timing of positive financial performance of the company in future
which may be dependent on the industrial scenario, possibility of infusion of
additional funds and the overall macro economic environment. If the company is
expected to improve its financial position in the future, the following discounted
cash flow model may be used for the distress companies / NPAs.


Liquidation value approach


       If the loan is in default with no or low expectation of it being serviced, the
cash flow from liquidation of the asset and collateral will be the primary approach
rather than the net present value of the cash flows. In this case, the take-out of
the lender is primarily by way of exercise of their rights on the asset and attached
collateral. The liquidation value of the company is the aggregate of the value of
the assets of the company if sold at the market prices, net of transactions and
legal costs. The estimation of the assets becomes quite complicated when the
assets of the company cannot be easily separated like in a steel, textile or
petrochemical plant. If such assets are sold individually, majority of the asset
may not fetch a price closer to their book value (or when they are sold as a
bundle). Further, when such sale is to take place at a quick pace, the value of the
assets further fall down, as it is more or less equal to forced sale of these assets.
As a result of this forced sale, the seller has to accept a discount on the fair
market value of such assets. In most cases, such a realization is not able to
cover even the secured debt fully and hence the valuation of the debt would be
limited by this realizable value. This approach has been widely used in countries
like Thailand where a significant number of loans were secured by real estate
and other marketable securities of various kinds.
Earning model




                                                                                  15
       In performing companies, the P/E ratio of the industry or other similar
companies may be used as a tool for determining the market value of the assets
of company. If the debt of the company is more than its assets, then a
proportionate discount may be applied to the debt. The above approach,
however, cannot be used for most of the NPAs, as they would have negative
EPS. In such cases, the cash earning per share of the company and cash P/E
ratio of the similar companies may be used to arrive at a market value of the
assets. This shall enable the analyst to arrive at a reasonable valuation of the
NPA debt.


Case specific valuation models


       Depending on case to case, various models have been evolved and used
for specific requirements. I shall discuss here one of such models to provide an
idea as to how varied the models can be from the conventional approaches.


Segmentation into buckets


       For a huge portfolio of small loans, different kind of approach may be used
for arriving at the realistic valuation. One of them is categorizing the loans in
various buckets and then analyzing a sample picked from various buckets. Post
currency crisis of late 1990’s in Thailand, the price of real estate had declined to
abysmally low levels and majority of the property-linked loans had become NPAs
in the books of the local banks. One of the leading financial companies in the
world was contemplating to purchase these loans totaling over 20,000 small
loans. For arriving at the appropriate valuation, they had followed the following
methodology:


      Segmentation of the assets in various buckets
      Selection of a sample out of each bucket
      Detailed analysis of each sample
      Statistical extrapolation of the sample to the entire bucket


                                                                                 16
   Arriving at the final range of the valuation of the portfolio




                                                                    17
              FACTORS RESPONSIBLE FOR NPAs


       The dues of the Banking sector are generally related to the performance
of the unit / industrial segment. In a few cases, the cause of NPA has been due
to internal factors (to the banks) such as weak appraisal or follow-up of loans but
more often than not, it is due to factors such as management inefficiency of
borrowal units, obsolescence, lack of demand, non-availability of inputs,
environmental factors, etc.


The main reasons for sickness and the factors leading to NPA are as under –


INTERNAL FACTORS:


      Diversion of Funds – for expansion, modernization, setting up of new
       projects, helping or promoting sister concerns.


      Time / Cost overruns while implementing the project.


      Business failure like product failing to capture market, inefficient
       management, strike / strained labour relations, wrong technology,
       technical problems, product obsolescence, etc.




   EXTERNAL FACTORS:


      Failure, non-payment / overdues in other countries, recession in other
       countries, externalization problems, adverse exchange rates, etc.


      Government policies like excise, import duty changes, deregulation,
       pollution control orders, etc.




                                                                                18
        Willful default, siphoning of funds, Fraud, misappropriation, promoters /
         management disputes, etc.


        Deficiencies on the part of the Banks, viz., in credit appraisal, monitoring
         and follow-up, delay in release of limits, delay in settlement payments /
         subsidies by Government bodies, etc.


        External factors like raw material shortage, raw material / input price
         escalation, power shortage, industrial recession, excess capacity, natural
         calamities like floods, accidents, etc.


         Contribution to NPAs by factors like siphoning off funds thorough
Fraud/misappropriation was less significant in comparison with other factors.

         Incidence of NPAs on account of deficiencies on the part of banks such as
delay in sanction and disbursement of funds whereby borrowing units are starved
of funds when in need, and delay in settlement of payments/subsidies by the
Government bodies was on the low side in proportion to other factors.

         Lack of effective co-ordination between banks and financial institutions in
respect of large value projects does contribute to the emergence of NPAs even
at the implementation stage. RBI had, in February 2000,drawn up certain ground
rules in this regard in consultation with banks, financial institutions and IBA and
circulated the same among banks and financial institutions for implementation.

         Susceptibility of the sanctioning authorities to external pressure, failings of
the CEOs and the ineffectiveness of the Board to check his ways also
contributed in no small measure to the unusual build up of NPAs in some of the
banks.

         One of the most prominent causes for NPAs, as often observed by RBI
Inspectors, is the slackness on the part of the credit management staff in their
follow up to detect and prevent diversion of funds in the post-disbursement stage.



                                                                                     19
Impact of Priority Sector Advances on NPAs –


       There is a common perception that the prescription of 40% of the net bank
credit to priority sectors have led to higher level of NPAs, because credit to these
sectors become sticky. However, it has been observed that the proportion of
NPAs in these sectors is lesser than the proportion of NPAs in the Non-Priority
sector, although, the incidence of NPAs in the priority sectors is much higher.


       The gradual increase in the proportion of the NPAs in the Non-priority
sectors indicates that NPAs are increasingly occurring on borrowal accounts of
Industrial sector during the recent years.




                                                                                  20
                STATISTICS PERTAINING TO NPAs

NPA OF INDIAN BANKS


        The Non Performing Assets (NPA) of 27 public sector banks shot up to
Rs.56,608 crore in September 2001. NPA not only reduces the yield on
advances but also reduces the profitability of banks. The huge NPA's of the bank
is due to the debtor friendly foreclosure and bankrupt laws which allows
customers to default with


                                                             (Rs. In crores)
                                                             Net NPA as
                         Gross NPA as % of
Year       Gross NPA                            Net NPA     %    of     net
                         Gross advance
                                                            advances
1993         39,253             23.2%              NA             NA
1994         41,041             24.8%              NA             NA
1995         38,385             19.5%            17,567         10.7%
.1996        41,661              18%             18,297          8.9%
1997         47,300             15.7%            22,340          8.1%
1998         50,815             14.4%            23,761          7.3%
1999         58,722             14.7%            28,020          7.6%
2000         53,066              13%             26,596          7%
2001         56,608              13%             27,856          7%

        It will be also interesting to have a look at the movement of NPAs (gross
and net), as a percentage of advances, group-wise over the last four years. This
will give an idea of where banks, as different groups, stand in regard to their
NPAs.




Percentage of gross / net NPAs to total advances as at end March




                                                                               21
Bank Groups                   1998     1999     2000      2001

Public sector banks           16.0     15.9     14.0      12.4
                              (8.2)    (8.1)    (7.4)     (6.7)

All private sector banks      8.7      10.8     8.2       8.5
                              (5.3)    (7.4)    (5.4)     (5.4)

Old private sector banks      10.9     13.1     10.8      11.1
                              (6.5)    (9.0)    (7.1)     (7.3)

New private sector banks      3.5      6.2      4.1       5.1
                              (2.6)    (4.5)    (2.9)     (3.1)

Foreign banks                 6.4      7.6      7.0       6.8
                              (2.2)    (2.9)    (2.4)     (1.9)

All commercial banks          14.4     14.7     12.7      11.4
                              (7.3)    (7.6)    (6.8)     (6.2)

Note: Figures in parenthesis denote percentage of net NPAs to net advances

       It may be observed that the malady of high level of NPAs eroding the
profitability of banks is not confined to public sector banks alone, but it is equally
present in the private sector banks too. While some of the foreign banks loan
portfolio had been affected by a few large accounts turning NPA, it is a matter of
concern that some of the new private sector banks, which started off, on a clean
slate had acquired so quickly such a large level of NPAs.




Share of NPAs in Net Advances



                                                                                   22
Bank Group             Number of Number of Banks Number of Banks with
                       Banks          with Higher Share Lower Share in Assets
                                      in Assets
Public        Sector        27           4          3             4            16
Banks
Old Private Sector          24          11          4             8            1
Banks
New          Private        8            8          --           --            --
Sector Banks
Foreign Banks               36          15          2            11            1
      Total                 95          38          9            23           18


         In all forums of interactions the global multilateral institutions and rating
agencies had with RBI and the Government, directed lending concept gets
quoted as an important attribute and a contributory factor for the build up of
NPAs in banks in India. It is a different matter that RBI and the Government are
accused of soft attitude towards banks which do not fulfill the prescribed targets
for priority sector lending, particularly agriculture and small scale sector. The
figures in the following table as on March 31, 2001 reveals information regarding
the contribution by various segments of borrowers to the NPA stock of public
sector banks: -




         Gross NPAs as on March 31, 2001

Borrowing         segment- Amount            Percentage to total



                                                                                    23
wise     distribution    of (Rs.          NPAs
gross NPAs                   crores)

Public sector units          1334.05              2.44

Large Industries             11498.10             20.99

Medium industries            8658.69              15.81

Other non priority sectors   9516.62              17.37

Agriculture                  7311.40              13.35

Small scale industries       10284.97             18.78

Other priority sectors       6169.33              11.26

Total                        54773.16            100.00




        It can be understood that recovery of NPAs under priority sector advances
particularly to agriculture and small-scale industries is sometimes hampered by
externalities. Further, such NPAs are also spread over a large number of
accounts and for small amounts. However, one fails to understand the reluctance
of large borrowers to honour their repayment obligations. In many cases, failure
of banks to take effective action against some of the defaulting large corporate
borrowers was also noticed.




                                                                              24
                        IMPLICATIONS OF NPAs

Supervisory action that may arise on account of high level of NPAs

       One of the trigger points in the proposed Prompt Corrective Action (PCA)
mechanism [which was widely circulated by RBI through the public domain] is the
level of net NPAs. When the trigger point under the mechanism is activated by
the performance of a bank, the mandatory actions would follow by way of
restriction on expansion of risk-weighted assets, submission and implementation
of capital restoration plan, prior approval of RBI for opening of new branches and
new lines of business, paying off costly deposits and special drive to reduce the
stock of NPAs, review of loan policy, etc.

Provisioning for NPAs – Based on the Asset classification, Banks are required
to   make   provision   against   the   NPAs at   –   100% for Loss Assets;
100% of the unsecured portion plus 20% to 50% of the secured portion,
depending on the period for which the account has remained in doubtful
category; and 10% general provision on the outstanding balance in respect of
Sub-standard assets. Banks have been asked to make provision @ 0.25% on
their standard advances.

Other implications

       The most important business implication of the NPAs is that it leads to the
credit risk management assuming priority over other aspects of bank's
functioning. The bank’s whole machinery would thus be pre-occupied with
recovery procedures rather than concentrating on expanding business.

       As already mentioned earlier, a bank with high level of NPAs would be
forced to incur carrying costs on a non-income yielding assets. Other
consequences would be reduction in interest income, high level of provisioning,
stress on profitability and capital adequacy, gradual decline in ability to meet
steady increase in cost, increased pressure on net interest margin (NIM) thereby
reducing competitiveness, steady erosion of capital resources and increased
difficulty in augmenting capital resources.


                                                                               25
       The lesser appreciated implications are reputational risks arising out of
greater disclosures on quantum and movement of NPAs, provisions etc. The
non-quantifiable implications can be psychological like ‘play safe’ attitude and
risk aversion, lower morale and disinclination to take decisions at all levels of
staff in the bank.




                                                                              26
       COMMITTEE ON BANKING SECTOR REFORMS:


       The Committee on Banking Sector Reforms (CBSR) report suggests
remedies to recover the NPAs as well their subsequent transfer as assets
through fund management. Some of the critical points are discussed here under:


   -   Where guarantees have been given by the central or state government
       and a demand thereunder has been raised by the banks, these demands
       should be honoured.


   -   Banks must put greater reliance upon the recommendations of the
       Settlement Advisory Committee (SAC) in order to make better use of
       compromises for reduction of NPAs in their books.


   -   The most effective way of removing NPAs from the books of the weak
       banks would be to move these out to a separate agency which will buy the
       loans and make its own efforts for their recovery.


   -   The proper financial vehicle through which non-performing loans can be
       transferred would be that of the FRA-owned (government) asset
       reconstruction (ARF) managed by the independent private sector Asset
       Management Company.


   -   The ownership of the assets will lie with the government and the
       management thereof with a separate private sector entity having the
       necessary expertise and organization.


   -   The ARF’s operations will be profit oriented and its aim will be to recover
       from the acquired assets (NPA) more than the price paid for it.


   -   The FRA and the ARF owned by it may be set up under a special act of
       the parliament which while protecting it against obstructive litigation from

                                                                                27
    the borrowers could also provide for quick and effective enforcement of its
    rights against them.




-   The government will provide the fund needed for the ARF. The size of the
    fund needed will depend upon the size of business it handle. Presently it is
    proposed that the ARF may restrict its activities to the NPAs of the three
    identified weak banks.


-   The ARF should focus on comparatively larger NPAs. It would be
    desirable not to acquire assets value below Rs.50 lakh.
-   The payment in respect of the assets purchased from the weak banks
    may be made by the ARF by issuing special bonds guaranteed by the
    government and bearing a suitable rate of interest.


-   The bonds issued by the ARF in payment of the assets acquired as also
    those which it will issue for raising funds against the security of the assets
    it has purchased and which are in the course of collection may have a
    maturity of five years.




-   The ARF should purchase from the banks loans, which are NPAs as on a
    certain date say, 31.3.2000. In view of the foregoing it will be adequate for
    the ARF to have a life of not more than seven years form the date of its
    commencing business, say beginning 1.4.2000.


-   To begin with, the ARF may buy NPAs of only the three identified weak
    banks. However buying NPAs from other banks need not be totally
    excluded.
-   If need arises, more ‘funds’ could be set up later. Participation in these
    funds may be open to both public and private sector. These funds can
    facilitate growth of secondary market for loans in the country.


                                                                               28
-   Price at which NPAs will be transferred should be arrived by mutual
    agreement and in a transparent manner.




-   In the ownership of the AMC while the government may have a share of
    upto 49 percent, majority shareholding should be non-government.
    Institutions like SBI, LIC, GIC, UTI and IFCI and parties form the private
    sector could be the other shareholders. The possibility of attracting
    participating of multilateral agencies like IFC or ADB should also be
    explored. The initial capital requirement of the AMC is not likely to be more
    than Rs. 15 crore.


-   Professionals such as bankers, chartered accountants, engineers, lawyers
    and valuers should man the AMC, which must have a lean structure, so
    that it has the desired expertise and is cost efficient.




                                                                              29
                 MEASURES TO RECOVER NPAs

Life Line of Banking: New RBI Formula for NPA Recovery


      Over the last few years Indian banking in its attempt to integrate itself with
the global banking has been facing lots of hurdles in its way due to its inherent
weaknesses, despite its high sounding claims and lofty achievements. One of the
major hurdles, the Indian banking is facing today, is its ever-growing size of non-
performing assets over which the top management of almost each bank is
baffled. On account of the intricacies involved in handling the NPAs the ticklish
task of asset management of the bank has become a tight rope walk affair for the
controlling heads, because a little wavering ‘ this or that side’ may land the
concern bank in trouble. The growing NPAs is a potent source of worry for the
finance minister as well, because in a developing country like ours, banking is
seen as an important instrument of development, while with the backbreaking
NPAs, banks have become helpless burden on the economy.


      RBI has announced the modified guidelines under the settlement advisory
committee (sac) scheme vide its letter no bp.bc.11.21.01 040/99-00 dated 27th
July 2000. A specific time frame was also stipulated in the scheme, but due to
various reasons the scheme could not make any sizeable dent into the problem.
Therefore, realizing the obstacles in handling the NPAs and solving the issue in a
meaningful, and realistic manner, RBI now have come out with a fresh set of
guidelines under the modified sac schemes discussed hereunder.


      Laying stress on the timeframe, the scheme looks more definitive and
decisive, as cut off dates have been fixed for the implementation of the scheme.
Under the scheme, detailed guidelines have been issued by RBI to cover NPA
with outstanding amount upto Rs.5 crore. However for outstanding amount above
Rs. 5 crore, policy formulation for the settlement of the account is left with the
concerned bank it is observed that majority of the NPA constitute accounts with
outstanding amount below rupees five crores. Thus by following the provisions of


                                                                                 30
the revised schemes, the size of the NPAs can be reduced to a level acceptable
as per the international norms. As per the guidelines, the scheme covers NPAs,
which have become doubtful or loss assets as on 31.3.1997. Further the scheme
also covers NPA classified as sub-standard as on 31.3.1997, but later on
becoming doubtful or loss assets.


NPAs with outstanding upto Rs. 5 crore


       In case of doubtful and loss assets as of 31.3.1997, through the modified
schemes, the banks have been directed to follow up a settlement formula under
which the minimum amount to be recovered, amounts to be entire outstanding
running ledger balance as on the date the account was identified as NPA i.e. the
date from which the interest was not charged to the running ledger, an analysis
of the given formula shows that RBI has been very much generous in granting
huge relaxation to the borrowers who were not coming forward for setting their
overdue loans due to one or other reason. The scheme is of high practical value
as it protects the borrowers who were having genuine problems in clearing their
dues because the interest component constituted a multiplied amount of principal
outstanding. On the other hand, the concerned banks were also finding in difficult
to sacrifice the entire interest component, but outstanding in the dummy ledger.
Now as per the provision to he scheme, they will be ready to grant such
relaxation in favour of the borrowers. These guidelines have come as a windfall
for borrowers who after a lot of negotiations, were almost ready to repay back
their principal as well as a part of the interest component to settle their accounts,
as under the modified scheme, they would be able to save the interest
component. To that extent the concerned bank stands to lose.


       In the case of sub-standard asset as of 31.3.1997, the settlement formula
as given in the modified scheme states that the minimum sum to be recovered
must contain the entire running ledger outstanding balance as on the date of the
account was identified as NPA. i.e. the date from which interest was not charged
to the running ledger + interest at the existing prime lending rate of the bank from


                                                                                  31
1.4.1997 till the date of final payment. As per the modified sac scheme, the terms
suggested for the payment of settlement amount of NPA are simple and
pragmatic. As per the terms of the scheme, the settlement amount should be
paid in lump Sum by the borrower. However in case of the borrower is unable to
repay back in a lump Sum, the scheme allows sufficient breathing period to
enable him to arrange the funds and clear at least 25 percent of the settlement
amount to be paid upfront and the remaining amount to be recovered in
installments spread over a period of one year along with interest at the existing
PLR from the date of settlement upto the date of final payment


       It is observed that each bank is having a system of delegation of authority
for the clearance of NPAs, so there should not be any operational problem in the
implementing of the scheme as per the modified guidelines.




NPAs with outstanding over Rs. Five crore


       For recovery of NPAs over Rs.5 crore, RBI has left the matter to the
concerned banks and advised that the concerned banks may formulate policy
guidelines regarding their settlement and recovery. The freedom, in such cases,
is given to the banks, because the attending circumstances in each case may
vary from the other. Therefore it was in the right direction that adopting a
generalized approach was not thought appropriate.


       In cases, where the amount involved is above Rs.5 crore, RBI expects
CMD of each bank to supervise the NPA personally. The CMDs of the concerned
banks are advised to review all such cases within a given timeframe and decide
the course of action in terms of rehabilitation/restructuring. OTS or filing of suits
by 31st August 2000.It is also expected that in all such cases, the matter be
placed before the boards of the concerned banks for finalising the course of
action by 31.9.2000. Further it is also clarified that in cases where a legal suit is
required to be filed, the same should be filed in all such cases by 31.10.2000 and


                                                                                  32
it should be vigorously followed up. RBI also desires the submission of a
quarterly report of all NPAs above Rs.5 crore from the PSU banks. Thus by
putting up the cut-off dates for the implementing of the scheme, RBI desires the
banks to realize the seriousness of the issue and gear up to sweep away the
NPAs in one go.


       For the commercial banks, it is a golden opportunity to clear the mess,
consolidate and come out on a track leading to the path of global banking. The
time given for weeding out the disastrous NPAs is neither too long nor too short
and the banks, with proper planning and follow up can drastically reduce their
NPAs, if they firmly resolve to do so.


       RBI expects the commercial banks to follow the guidelines in letter and
spirit without any discrimination or discretion as a slight dilution may jeopardize
their interest. A proper monitoring system is also desired to be evolved for
monitoring the progress of the scheme. As this is a rare opportunity given to the
defaulting borrowers, so that they can avail the chance given for the settlement of
their loans. Without adequate publicity of the scheme, the response from the
defaulting borrowers may not be there to the expected level.


       It is a matter of concern that out of 27 public sector banks only three or
four are able to manage to restrict their NPA level to below 5 percent. The
Narsimham committee had pointed out in its report of 1998 that we seek
consolidation by looking at the problem of NPAs from a relative angle. We find it
comfortable to read NPA as a percentage to total advances, which reduced from
23.2 percent at the end of March 1993 to 16 percent at the end of March 1998
and further down to 15.9 percent at the end of March 1999. While in absolute
terms total NPA of public sector banks increased from Rs.39250 crore as on
March 1993 to Rs.45653 crore as on march 1998 to Rs.58554 crore as on march
1999. The modified scheme announced by RBI has come at the right moment
when it is badly needed. The banking industry is ready to take it in the right




                                                                                33
prospective, but it is successful implementation depends upon a number of
factors as enumerated below:
   -   The success of the scheme would be limited to the level of seriousness
       evinced by the concerned banks. If it is taken as a routine guideline from
       the RBI and disposed of without attaching the importance it deserves, it
       may end up as any other routine matter.
   -   Looking to the gravity of the issue, the rate of success of the scheme
       depends upon the publicity given to the golden opportunity available
       among the defaulting borrowers. It is felt that the scheme must reach
       every nook and corner of the country as the disease reflected in the form
       of NPA is not restricted to a particular area or pockets in the country.
   -   It is also required that the progress of the implementation of the scheme
       be assessed periodically by evolving an alert monitoring system by each
       bank. As the implementation of the scheme is going to decide the destiny
       of the concerned bank, it is absolutely necessary that an effective
       monitoring system is there to ensure successful implementation of the
       scheme.
   -   It is also essential that while settling the NPA as a dispassionate and
       unprejudiced approach is adopted without any discrimination failing which
       the banks will not be able to weed out NPAs.
   -   A multifrontal approach to the problem involving all the concerned staff
       members in the field as well as in the controlling points is another
       condition for proper implementation of the scheme. In the absence of
       teamwork involving a top management as well as everybody upto the
       grassroot level, the banks would not be able to root out the problem.


Measures initiated by Reserve Bank and Government of India for reduction
of NPAs

Compromise settlement schemes

The RBI / Government of India have been constantly goading the banks to take
steps for arresting the incidence of fresh NPAs and have also been creating legal


                                                                                  34
and regulatory environment to facilitate the recovery of existing NPAs of banks.
More significant of them, I would like to recapitulate at this stage.


      The broad Framework for compromise or negotiated settlement of NPAs
       advised by RBI in July 1995 continues to be in place. Banks are free to
       design and implement their own policies for recovery and write-off
       incorporating compromise and negotiated settlements with the approval of
       their Boards, particularly for old and unresolved cases falling under the
       NPA category. The policy Framework suggested by RBI provides for
       setting up of an independent Settlement Advisory Committees headed by
       a retired Judge of the High Court to scrutinise and recommend
       compromise proposals.




      Specific guidelines were issued in May 1999 to public sector banks for one
       time non-discretionary and non-discriminatory settlement of NPAs of small
       sector. The scheme was operative upto September 30, 2000. [Public
       sector banks recovered Rs. 668 crore through compromise settlement
       under this scheme.]




      Guidelines were modified in July 2000 for recovery of the stock of NPAs of
       Rs. 5 crore and less as on 31 March 1997. [The above guidelines which
       were valid upto June 30, 2001 helped the public sector banks to recover
       Rs. 2600 crore by September 2001]




                                                                              35
      An OTS Scheme covering advances of Rs.25000 and below continues to
       be in operation and guidelines in pursuance to the budget announcement
       of the Hon’ble Finance Minister providing for OTS for advances up to
       Rs.50, 000 in respect of NPAs of small/marginal farmers are being drawn
       up.


Measures for faster legal process

Lok Adalats

       Lok Adalat institutions help banks to settle disputes involving accounts in
"doubtful" and "loss" category, with outstanding balance of Rs.5 lakh for
compromise settlement under Lok Adalats. Debt Recovery Tribunals have now
been empowered to organize Lok Adalats to decide on cases of NPAs of Rs.10
lakhs and above. The public sector banks had recovered Rs.40.38 crore as on
September 30, 2001, through the forum of Lok Adalat. The progress through this
channel is expected to pick up in the coming years particularly looking at the
recent initiatives taken by some of the public sector banks and DRTs in Mumbai.

Debt Recovery Tribunals

       The Recovery of Debts due to Banks and Financial Institutions
(amendment) Act, passed in March 2000 has helped in strengthening the
functioning of DRTs. Provisions for placement of more than one Recovery
Officer, power to attach defendant’s property/assets before judgment, penal
provisions for disobedience of Tribunal’s order or for breach of any terms of the
order and appointment of receiver with powers of realization, management,
protection and preservation of property are expected to provide necessary teeth
to the DRTs and speed up the recovery of NPAs in the times to come.

       Though there are 22 DRTs set up at major centers in the country with
Appellate Tribunals located in five centers viz. Allahabad, Mumbai, Delhi,
Calcutta and Chennai, they have not been able to deliver as expected as they
got swamped under the huge volume of cases (41,243) filed with them, since
inception, out of which 35,871 cases were still pending as on 31.3.2002. Banks


                                                                               36
could recover Rs. 2,947 cr only, which is less than 1% of the amount claimed
through the DRT mechanism up to 31.3.2002.

       The banks should institute appropriate documentation system and render
all possible assistance to the DRTs for speeding up decisions and recovery of
some of the well-collateralized NPAs involving large amounts. I may add that
familiarization programmes have been offered in NIBM at periodical intervals to
the   presiding   officers   of   DRTs   in   understanding   the   complexities   of
documentation and operational features and other legalities applicable of Indian
banking system. RBI on its part has suggested to the Government to consider
enactment of appropriate penal provisions against obstruction by borrowers in
possession of attached properties by DRT receivers, and notify borrowers who
default to honour the decrees passed against them.

Circulation of information on defaulters

       The RBI has put in place a system for periodical circulation of details of
willful defaults of borrowers of banks and financial institutions. This serves as a
caution list while considering requests for new or additional credit limits from
defaulting borrowing units and also from the directors /proprietors / partners of
these entities. RBI also publishes a list of borrowers (with outstanding
aggregating Rs. 1 crore and above) against whom suits have been filed by banks
and FIs for recovery of their funds, as on 31 st March every year. It is our
experience that these measures had not contributed to any perceptible
recoveries from the defaulting entities. However, they serve as negative basket
of steps shutting off fresh loans to these defaulters. A real breakthrough can
come only if there is a change in the repayment psyche of the Indian borrowers.

Recovery action against large NPAs

       After a review of tendency in regard to NPAs by the Hon’ble Finance
Minister, RBI had advised the public sector banks to examine all cases of willful
default of Rs 1 crore and above and file suits in such cases, and file criminal
cases in regard to willful defaults. Board of Directors are required to review NPA



                                                                                   37
accounts of Rs.1 crore and above with special reference to fixing of staff
accountability.

       On their part RBI and the Government are contemplating several
supporting measures including legal reforms, some of them I would like to
highlight.

Asset Reconstruction Company:

       An Asset Reconstruction Company with an authorised capital of Rs.2000
crore and initial paid up capital Rs.1400 crore is to be set up as a trust for
undertaking activities relating to asset reconstruction. It would negotiate with
banks and financial institutions for acquiring distressed assets and develop
markets for such assets. Government of India proposes to go in for legal reforms
to facilitate the functioning of ARC mechanism

Corporate Debt Restructuring (CDR)

       Corporate Debt Restructuring mechanism has been institutionalised in
2001 to provide a timely and transparent system for restructuring of the corporate
debts of Rs.20 crore and above with the banks and financial institutions. The
CDR process would also enable viable corporate entities to restructure their dues
outside the existing legal Framework and reduce the incidence of fresh NPAs.
The CDR structure has been headquartered in IDBI, Mumbai and a Standing
Forum and Core Group for administering the mechanism had already been put in
place. The experiment however has not taken off at the desired pace though
more than six months have lapsed since introduction. As announced by the
Hon'ble Finance Minister in the Union Budget 2002-03, RBI has set up a high
level Group under the Chairmanship of Shri. Vepa Kamesam, Deputy Governor,
RBI to review the implementation procedures of CDR mechanism and to make it
more effective. The Group will review the operation of the CDR Scheme, identify
the operational difficulties, if any, in the smooth implementation of the scheme
and suggest measures to make the operation of the scheme more efficient.




                                                                               38
Credit Information Bureau

         Institutionalisation of information sharing arrangements through the newly
formed Credit Information Bureau of India Ltd. (CIBIL) is under way. RBI is
considering the recommendations of the S.R.Iyer Group (Chairman of CIBIL) to
operationalise the scheme of information dissemination on defaults to the
financial system. The main recommendations of the Group include dissemination
of information relating to suit-filed accounts regardless of the amount claimed in
the suit or amount of credit granted by a credit institution as also such irregular
accounts where the borrower has given consent for disclosure. This, I hope,
would prevent those who take advantage of lack of system of information sharing
amongst lending institutions to borrow large amounts against same assets and
property, which had in no small measure contributed to the incremental NPAs of
banks.

Proposed guidelines on willful defaults/diversion of funds

         RBI is examining the recommendation of Kohli Group on willful defaulters.
It is working out a proper definition covering such classes of defaulters so that
credit denials to this group of borrowers can be made effective and criminal
prosecution can be made demonstrative against willful defaulters.

Corporate Governance

         A Consultative Group under the chairmanship of Dr.A.Ganguly was set up
by the Reserve Bank to review the supervisory role of Boards of banks and
financial institutions and to obtain feedback on the functioning of the Boards vis-
à-vis compliance, transparency, disclosures, audit committees etc. and make
recommendations for making the role of Board of Directors more effective with a
view to minimising risks and over-exposure. The Group is finalising its
recommendations shortly and may come out with guidelines for effective control
and supervision by bank boards over credit management and NPA prevention
measures.

OTHER MEASURES TO CURB NPA:



                                                                                39
       Banks need to have better credit appraisal so as to prevent NPAs from
occurring. However once NPAs do come into existence, the problem can be
solved only if there is enabling legal structure, since recovery of NPAs often
requires litigation and court orders to recover stuck loans. With long-winded
litigation in India, debt recovery takes a very long time. But according to the new
union budget of 2001-02 this problem will soon cease to exist


       Banks will get the teeth to salvage their stucky loans. Bad loans, which
have dropped from 14 percent of total assets to 7.4 in the past decade, may now
come down to the internationally accepted 5 percent level if the proposed
foreclosure laws are enacted. Besides bankers said the decision to form seven
more debt recovery tribunals will improve loan recovery. The proposed repeal of
the sick industrial companies act will also prevent defaulting companies form
taking refuge in the board for industrial and financial reconstruction.


       “The setting up of additional tribunals, repealing of SICA and amendment
of foreclosure norms will go a long way in helping banks recover non performing
assets” said Janki Ballabh, chairman SBI. “Under the current system, banks have
to file a suit and obtain a court decree to attach the property that is mortgaged
with them. The new foreclosure norms will allow lenders to directly take
possession of property by giving a notice;” said P S Shenoy, chairman Bank of
Baroda.


       According to bankers, bad loans are one of the reasons why banks have
not been in a position to bring down lending rates further. With an average of
over 7 percent of total amount lent not coming back, banks have to build in the
cost of such delinquencies into their lending rates.


       Although the Finance Minister has not announced any specific measures
for the three weak banks, the new foreclosure norms if implemented will go a
long way in getting the weak banks back on track.


                                                                                40
       The BIFR was constituted with the intention of providing an opportunity to
sick companies to get back on the rails by keeping lenders at the bay until they
restructured their operations. Corporate have, however been misusing these
provisions by making an application to the BIFR as soon as banks sent them
notices to recover the loans.


       Banks are now working on developing debt recovery tribunals to solve this
problem. The government has also mooted the suggestion of an asset
reconstruction company, which will be a specialized agency set up for
rehabilitating revival NPAs and recovering funds out of unrevivable NPAs


       Experts have also suggested the concept of narrow banking, where only
strong and efficient banks will be allowed to give commercial loans, while the
weak banks will take positions in less risky assets such as government securities
and inter bank lending. One way of curbing NPA is a massive one-time write off
bad loans in its balance sheet. This could be aimed at bringing down the net non
performing assets closer to the targeted 5 percent from the present level of
around 7 percent of net advances.


       A classic example could be that of ICICI which have written off its bad loan
in its balance sheet for the year 2000-01


       ICICI net NPAs outstanding as on 31.12.2000 were Rs.4215 crore. The
ratio of net NPA to net advances declined to 7.2 percent as on 31.12.2000 from
7.6 as on 31.3.2000. Bringing down the NPA below 5 percent will help the
institution obtain a clearance from the reserve bank of India for setting up a non-
life insurance subsidiary.


       Bringing the NPAs down to 5 percent in one stroke will require
provisioning of over Rs.1000 crore, going by the last figure. Last year (99-00)




                                                                                41
ICICI had made enhanced provisions and write offs of Rs.690 crore (Rs.478
crore in 98-99) and had earned a profit after tax of Rs. 1206 crore.


        RBI had earlier said that non-banking finance companies would need to
contain their NPAs at below 5 percent to be eligible to promote insurance
companies.


Resolution of NPAs in the Asian Context


        To understand better the way that can be used to resolve the issue of
NPAs, case study of KOREA have been described below which show as to how
this nation have tackled the issue through the setting up of Asset Management
Companies.




Korea


        In resolving NPA problems, the Korean government relied on a centralized
AMC approach. The government had in 1997, assigned the role of purchase of
bad loans to the Korea Asset Management Corporation (KAMCO). Also bank-
based AMCs were created for the sale of bad loans of two major banks. KAMCO
was established in 1996 for the foreclosure and sale of assets attached to for tax
arrears, the liquidation of corporations and the NPA Fund, KAMCO’s role was
expanded to include the purchase of NPAs to assist in the rehabilitation of the
financial sector. KAMCO became a bad bank and a non-performing asset fund
was created to finance the purchase of NPAs. The government of Korea, Korea
Development Bank and 24 banks are joint shareholders of KAMCO. Most of its
funds come from bonds, which are issued for a period of 3 years and yield a
quarterly interest applicable to the Korean Development Bank. The balance
comes from the central bank, financial institutions and Korea Development Bank.
The main goal of the KAMCO was to speedily dispose off NPAs to better the
liquidity and soundness of the financial institutions, and this is to be


                                                                               42
accomplished by 2003. To begin with, KAMCO paid for the bad loans partly in
cash and partly in bonds but from 1998 onwards it was done through KAMCO
bonds (Cooke & Foley, 2000). In the past, KAMCO had purchased NPAs from
financial institutions in batches at fixed amounts up front, based on the expected
recovery value of the portfolio. KAMCO had then engaged in due diligence
process on each NPA, adjusted the initial price and then resettled depending on
the nature of each loan and asset. In September 1998, there was a change in the
acquisition method to a fixed purchase rate. KAMCO purchases were exempt
from acquisition and registration fees but this did not carry forward for
subsequent purchasers of the assets from the investor.


       KAMCO had planned recoveries though asset-backed securitization
schemes or outright sales or workout schemes. In a December 1998 auction,
Texas based Lone Star Fund purchased W 565 bn for W201 bn (a 64% discount)
from KAMCO. KAMCO had acquired the debts collateralized by 1500 houses,
buildings and factories from financial institutions for W204 bn. This was
KAMCO’s first sale of assets using an international securitization vehicle under
Korea’s asset backed securities law. KAMCO’s strategies for recovery were debt
restructuring (partial debt forgiveness, amended terms and debt-equity swaps),
outright sales (loans sold individually or packaged in portfolios and offered to
investors), asset-backed and equity partnerships securities. These assets were
transferred to a SPV trust, which in turn issued debentures and bonds to be sold
to institutional investors. KAMCO also went in for foreclosure auctions where
they could dispose off the assets through court auctions and asset restructuring.
KAMCO had issued CLOs and MBSs using the assets bought from banks and
properties obtained through exercising collateral rights. These CLOs were
guaranteed by KAMCO and carried a put option to sell the loan assets back to
the banks in case the loan fell into default.


The use of securitization to resolve NPAs




                                                                               43
       In recent times, securitization has been used by banks and AMCs to
dispose off their NPAs. The securitization market has hence, assumed a role of
specific importance in the context of NPAs (Kendall, 1996). Asset securitization is
the conversion of assets or cash flows into securities, which are typically rated
and called Asset-Backed securities (ABS). This has become popular for the
disposal of NPAs as it brings with it benefits to both the issuer and investor. For
issuers, it offers cheaper and more efficient funding for operations combined with
greater balance sheet flexibility. For investors, securitization provides a broad
selection of fixed income investment alternatives, most with higher credit ratings,
higher yields, less downgrade risk than corporate bonds and more stable and
predictable cash flows than other fixed income securities. Variants that have
been introduced include Mortgage backed securities (MBS) and Collateralized
bond and loan obligations (CBOs and CLOs). A CBO is an asset-backed security
supported by an underlying portfolio of high yield bonds (Albulescu). They are set
up to capture the arbitrage sometimes available from the yield differential
between the high yield and investment grade debt markets. They are created by
issuing multiple debt tranches to investors to finance the purchase of the
underlying portfolio. The most senior tranche receives investment grade status
by virtue of priority call on the cash flows from the high yield debt portfolio. The
other tranches have junior priority rights to this cash flow. The most junior
tranche is considered equity, which receives income after all the income spread
after commitments to the senior tranches and expenses are met. This process
can be used in the disposition of NPAs where the asset can be sold in this
manner such that the claims on the cash flows would follow a pre-determined
pattern.




                                                                                 44
                          SECURITISATION ACT
       All the measures mentioned before have been able to help banks recover
a small fraction of their NPAs. But slippages of advances from the performing to
the non-performing category has outstripped the recoveries of NPAs, as such,
the problem kept on aggravating year after year and reached such a level that
government was left with no option except to take drastic measures and
promulgate the Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Ordinance in June 2002 and repromulgation
thereof again in August 2002. This Ordinance was later replaced by the
Securitization Act in December 2002.

       Securitization Act is a fine, comprehensive and an extraordinary piece of
legislation. It is a giant leap forward in the realm of financial sector reforms. It is a
most reassuring sign of government's commitment to reforms. It fully addresses
all concerns with regard to lenders' interests and all attendant legal aspects. This
Act is revolutionary in the Indian context, as it gives sweeping powers to banks
and financial institutions to seize the assets charged to them without intervention
of courts and sells them off to realize their loans, which have become NPAs. The
Act provides a framework for securitization of stressed assets. It provides a
window to banks and financial institutions to deal with illiquid assets and
strengthens their right of foreclosure and enforcement of securities.

Salient features of Securitization act

       The secured creditor has been vested with two options under the Act. It
can either transfer the Security Interest to a Securitization or a Reconstruction
Company or enforce the provisions of the Act on its own, without the intervention
of the court. As per Section 35, the provisions of this Act override all other laws
for the time being in force notwithstanding anything inconsistent therewith
contained therein. Further as per Section 37, the provisions of this Act or the
rules made thereunder are in addition to and not in derogation of the Companies
Act, 1956, Securities Contract (Regulation) Act, 1956, the SEBI Act, 1992 (15 of




                                                                                      45
1992) and Recovery of Debts due to Banks and Financial Institutions, Act, 1993
(51 of 1993) or any other law for the time being in force.

i.) The Secured Creditor, may require the borrower (whose debt has been
classified as NPA by the Secured Creditor), by notice in writing to discharge his
liabilities in full within 60 days from the date of the notice, failing which the
Secured Creditor can exercise all or any of the following rights under sub-section
13(4) to recover his Secured Debt.

a. Take possession of Secured Assets of the borrower including right to transfer
by way of lease, assignment or sale for realizing the Secured Assets.

b. Takeover the management of the Secured Assets of the Borrower including
right to transfer by way of lease, assignment or sale for realizing the Secured
Assets.

c. Appoint any person as Manager to manage the Secured Assets, the
possession of which has been taken over by the Secured Creditor.

d. Require any person, who has acquired any of the Secured Asset from the
Borrower from whom any money is due and payable to Borrower, to pay the
same to the Secured Creditor, as is sufficient to repay the secured debt.

ii.) In case a Financial Asset has been jointly financed by more than one secured
Creditors, under Consortium or Multiple Banking Arrangement, no Secured
Creditor will be entitled to any or all of the above-said rights conferred on him u/s
13(4) of the Act, unless it is agreed upon by the Secured Creditors representing
not less than 3/4th in value of the amount outstanding as on record date and such
actions will be binding on all Secured Creditors.

iii.) Where dues of the Secured Creditor, are not fully satisfied, with the sale
proceeds of the Secured Assets, the Secured Creditor can file an application with
the Debt Recovery Tribunal having jurisdiction or a competent Court of Law for
recovery of the balance amount from the Borrower.




                                                                                  46
iv.) Secured Creditor(s) can proceed against the guarantor(s) or sell the pledged
Assets without first taking any of the measures specified in clause (a) to (d) of
sub-section 13(4) in relation to the Secured Assets, under the Act.

v.) Secured Creditors can take over the management of the business of the
defaulting Borrowers and appoint Directors where the Borrower(s) is a company
or Administrator of the business in any other case, by publishing a Notice in
newspaper in English and any other Indian language of the area, in which
principal office of the borrower is situated.

vi.) Once a Notice preparatory to repossession is received, the borrower cannot
alienate the Secured Asset(s) in question.

vii.) Banks can package and sell Loans via Securitization. Loans can be traded
among Banks, like Bonds or Shares.

viii.) Transactions to which the Act is not applicable.

The provision of the Act shall not, inter alia, apply to

a. Any Security Interest created in the Agricultural Land.

b. Any Debt where the amount due is less than 20% of the Principal amount and
Interest thereon.

c. Any Security Interest for securing repayment of any financial asset not
exceeding Rs. 1 lakh.

d. Pledge of Movable assets within the meaning of section 172 of Indian Contract
Act 1872.

e. Any conditional sale, hire purchase or lease or any other contract in which no
Security Interest has been created.

ix.) Right of Appeal though flat powers have been conferred on the Secured
Creditors (Banks and Financial Institutions) for taking possession of assets, right
to appeal is also given to the borrowers against the steps like possession of
assets taken by the banks. The aggrieved borrower can file appeal u/s 17 before


                                                                                47
the DRT within 45 days from the date of initiation of steps, though 75% of the
amount stated in Notice or such lower amount as DRT may direct, is required to
be deposited with the DRT concerned. Similar right of appeal before DRAT within
30 days is given u/s 18 to any person aggrieved by the order of the DRT. Thus
the Act restricts frivolous or dilatory appeals. The Act ousts the jurisdiction of the
Civil Courts and mandates that no Injunction shall be granted in respect of any
exercise of rights conferred by or under this Act.

Action taken by banks

       Banks and financial institutions have already started taking action under
this Act swiftly. Notices have since been flashed to thousands of borrowers
involving several thousand crores of NPAs. Borrowers, who never responded to
the calls of the banks earlier and have been playing hide and seek game with
them, have now seen the writing on the wall and have started responding
positively. They are coming forward to settle their dues with banks. Settlements
are being reached as per RBI norms and banks' own recovery management
policies. Cash recoveries have started pouring in. Where the borrowers have not
responded to the 60-day notices, the banks have tightened the noose and have
started procuring Seizure Orders from District Magistrates (DMs) or Chief
Metropolitan Magistrates (CMMs). Secured Assets have since been seized in
several cases, which has compelled even hard-core defaulters to pay their dues.
Never before the banks have received such an overwhelming response to any
recovery measure taken by them earlier. Print media too is playing its part in
building up the euphoria by giving wide publicity to the steps taken/being taken
by banks. Despite initial hiccups, recovery of NPAs is gathering momentum.

A dream act for banks and financial institutions

       In my view, it is a dream Act for banks and financial institutions. It can
bring cataclysmic change in the financial sector. Borrowers will no longer be able
to take banks lightly and simply walk away with precious funds of the public. The
threat of taking over of the collateral assets and enforcement of loan covenants
has already begun to show positive results. So far NPA recoveries are estimated


                                                                                   48
to be in the region of 20%. During next 3-4 years, the banks hope to recover 50
to 60% of NPAs through such tough measures. Recovery of NPAs will
substantially bring down weighted average cost of working funds. It will pave the
way for lower lending rates and better bottom lines.

      This Act is an essential prerequisite for smooth operations. Banks have
got a shot in the arm with this Act. This Act has created the much needed
recovery climate. This has given major fillip to the banks to deal with defaulters
and reduce their NPAs. It has instilled a sense of urgency in borrowers to settle
their dues. This Act will not only help in improving the financial health of the
country, but also our moral fiber as a society by enforcing the sanctity of the
contracts. Indian economy has suffered immensely from the lack of legal
machinery for contract enforcement and strong lenders' rights. Successful
implementation of the Act will free massive misallocated resources, bring back
into circulation the same funds that have been locked up in sick assets. They will
simultaneously relieve the pressure for fresh investments and create an overall
multiplier effect that would boost employment, industrial activity and asset build
up, apart from more efficient use of new capital and loss of rent seeking. Banks
got to declare total war on the NPAs as it warrants action, on a war-footing basis.




Reality bites

The scope of the Act is limited. The provisions of the Act do not cover small loans
up to Rs. 1,00,000 and the unsecured loans. Security interest of the banks in
agricultural lands is also not covered. The secured loans are estimated to be just
30-35% of total NPAs of the banking industry.

There are several limitations, weaknesses and shortcomings in the Act. The
following issues need to be addressed at the earliest:


   1. Issues with regard to Stamp Duty chargeable for transfer of assets from
      the originators to Asset Reconstruction Company (ARC), has not been
      addressed in the Act. The Stamp Duty is a state subject; it would require


                                                                                 49
   initiatives from the respective state governments. As a matter of fact,
   these banking assets should be exempted from the levy of Stamp Duty.


2. The issue of pricing or fixing a realizable value on the assets is another
   question not addressed in the Act so far.


3. Who will pay statutory dues like overdue sales tax, excise duty, income
   tax, electricity charges and other local tax arrears after the management
   takeover option is exercised by the Secured Creditor. Legal position in this
   regard need to be defined very clearly.


4. The appointment of a manager for the management of the acquired
   assets, in consultation with the borrowers, whose assets have been
   seized by the banks, seems to be an utopian idea.


5. The Act provides for appeal and for appeal over appeal, again a lengthy
   judicial process that may delay execution proceedings.


6. In case of gone concerns i.e., concerns which have been closed down, the
   banks will have to go through the same rigmarole for disposal of security
   in possession of an official liquidator.


7. The Act provides for concurrence of Secured Creditors representing three-
   fourths in value of the amount outstanding where there are more than one
   Secured Creditors. This concurrence especially in cases of going
   concerns may not come through.


8. It is not clear whether the banks can use powers conferred under the Act
   to enforce the Security Interest simultaneously in cases pending with BIFR
   and or DRT or the Doctrine of Election will come to play.




                                                                            50
9. Section 13(4) provides for management of Secured Assets only. Where a
   company has hundreds of assets, the management of isolated assets is
   how far feasible is difficult to decide and the Act is silent on this point.


10. In law, one cannot do indirectly what is prohibited directly. In case of sale
   of seized assets, the seller and the beneficiary will be the same. The sale
   of Secured Assets by banks at value enough to cover their dues would be
   adequately self-serving, but may appear to be unfair to the stakeholders.


11. In case of management control over the business of the defaulter(s), the
   Secured Creditor will have effective control over unsecured assets of the
   borrower as well, which contravenes the stipulated intent of the Act.


12. It will be difficult for banks to sell distressed assets, as there will be few
   takers for such assets. The corporate(s) may gang up to prevent sale of
   assets by banks. Auctions may turn out to be farce.


13. The Act empowers the banks to takeover the management of defaulting
   companies. Banks are not business tycoons, or jacks of all trades who can
   run any business activity with guaranteed success. Banks are not even
   custodians or merchants of commodities.


14. The Act does not address the problem of lack of infrastructure and
   practical problems involved in sale of distressed assets.


15. In case of certain specific industries where an industrial license, specific
   government approval or permission or special rights like mining lease etc.,
   is   issued   in   the   name    of   the   borrowing    company,     will     such
   license/approval/permission be automatically transferred to the name of
   buyer/bank/concerned or not?




                                                                                    51
16. Will intangible assets like patents, brands, goodwill be deemed to be
   automatically transferred to the banks/buyers and defaulter won't have any
   right, title, or interest in such assets, once he has been divested of the
   secured assets charged to the bank.


17. The reason(s) behind exempting borrowers u/s 31 of the Act from the
   application of the Act, when amount due is less than 20% of principal and
   interest due thereon, is not understandable.


18. Valuation of assets and bidding process can trigger legal cases. There
   can be lack of unanimity among lenders also, as all lenders holding at
   least 75% stake in outstanding dues are required to agree to sell the
   assets of defaulters.


19. Borrowers might prefer objection on several issues before magistrates
   authorized to issue Seizer Orders and can transform into a potential
   enquiry into nature of Secured Assets, proper status, nature of liability and
   so on and so forth.


20. Lenders are vulnerable to prosecution by compliance authorities on many
   issues, despite the indemnity given under the Act to persons exercising
   the rights of Secured Creditors.


21. The Act provides for creating a Central Registry to record the particulars of
   transactions related to Securitization and Reconstruction of Financial
   Assets and Creation of Security Interest including electronic record of the
   same. It has not been clarified whether this registration would exempt
   ARCs and securitization companies from filing particulars with the State
   Registry simultaneously.




                                                                              52
   22. Last, but not the least, the extent to which a Secured Creditor can proceed
      against a third party acquirer of Secured Assets from the borrower has not
      been adequately addressed in the Act. It may open a Pandora's box of
      Legal proceedings with third parties for the Secured Creditors.




      With the enactment of this landmark Act, though a giant leap forward has
been taken, yet there is a long way to go. NPAs are not a one-time phenomena.
It is a continuous process. Until the root cause of NPAs is eliminated, they will
continue to generate with a vengeance. It is important to know the extent of
malady and the question of how large a hole has been created in our Indian
financial system by the NPAs? With the euphoria and the media hype that has
been created, it may appear that banks are having a party time, as they have got
the so called sweeping powers to rein in the recalcitrant borrowers. The Act is not
a financial TADA. It is a tool and not a weapon in the hands of the banks to shoot
the defaulters. It is an enabling provision, an extra right, which will be used by
banks very sparingly, as a last resort to nail the hardcore defaulters only.
Bankers have never been and they will never be capricious. They have always
been considerate and will remain so in future as well. Much of the initial delight
expressed by banks on the positives of the Ordinance is nothing, but a good old
brouhaha or an irrational exuberance. This unbridled optimism is also reinforced
by unbridled upward swing in Bank stocks in the bourses. The falling interest
rates, the banks' embracing state-of-the-art technology for anywhere, any time
and anyhow banking, the VRS in bank etc., could not create such a favorable
impact as much as this Act has done.




                                                                                53
                        MANAGEMENT OF NPAS

         The quality and performance of advances have a direct bearing on the
profitability and viability of banks. Despite an efficient credit appraisal and
disbursement mechanism, problems can still arise due to various factors. The
essential component of a sound NPA management system is quick identification
of non-performing advances, their containment at minimum levels and ensuring
that their impingement on the financials is minimum.

         The approach to NPA management has to be multi-pronged, calling for
different strategies at different stages a credit facility passes through. RBI's
guidelines to banks (issued in 1999) on Risk Management Systems outline the
strategies to be followed for efficient management of credit portfolio. I would like
to touch upon a few essential aspects of NPA management in this paper.

         Excessive reliance on collateral has led Indian banks nowhere except to
long drawn out litigation and hence it should not be sole criterion for sanction.
Sanctions above certain limits should be through Committee which can assume
the status of an 'Approval Grid'.

         It is common to find banks running after the same borrower/borrower
groups as we see from the spate of requests for considering proposals to lend
beyond the prescribed exposure limits. It is necessary that running after niche
segment may be fine in the short run but is equally fraught with risk. Banks
should rather manage within the appropriate exposure limits. A linkage to net
owned funds also needs to be developed to control high leverages at borrower
level.

         Exchange of credit information among banks would be of immense help to
them to avoid possible NPAs. There is no substitute for critical management
information system and market intelligence.

         We have come across cases of excellent appraisal and compliance with
sanction procedures but no control at disbursement stage over compliance with


                                                                                 54
the terms of sanction. To overcome this problem a mechanism for independent
review of compliance with terms of sanction has to be put in place.

       Close monitoring of the account particularly the larger ones is the primary
solution. Emerging weakness in profitability and liquidity, recessionary trends,
recovery of installments / interest with time lag, etc., should put the banks on
caution. The objective should be to assess the liquidity of the borrower, both
present and future prospects. Loan review mechanism is a tool to bring about
qualitative improvement in credit administration. Banks should follow risk-rating
system to reveal the risk of lending. The risk-rating process should be different
from regular loan renewal exercise and the exercise should be carried out at
regular intervals. It is not enough for banks to aspire to become big players
without being backed by development of internal rating models. This is going to
be a pre-requisite under the New Capital Adequacy Framework and if a bank
wants to be an international player, it shall have to go for such a system.

       Banks should ensure that sanctioning of further credit facilities is done
only at higher levels. A quick review of all documents originally obtained and their
validity should be made. A phased programme of exit from the account should
also be considered.




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                               CONCLUSION
       I am of the opinion that NPAs are better avoided at the initial stage of
credit consideration by putting in place rigorous and appropriate credit appraisal
mechanism. In the changing scenario banks cannot behave imprudently while
sanctioning credit and later run to supervisors / regulators for regulatory
forbearance and owners or strategic partners to bail them out.

       Secondly, the mindset of the borrowers needs to change so that a culture
of proper utilisation of credit facilities and timely repayment is developed. One of
the main reasons for corporate default is on account of diversion of funds and
corporate entities should come forward to avoid this practice in the interest of
strong and sound financial system.

       Finally, extending credit involves lenders and borrowers and both should
realise their role and responsibilities. They should appreciate the difficulties of
each other and should endeavour to work towards contributing to a healthy
financial system.

       I do hope that corporate entities would put their best foot forward in
creating an environment where a healthy, vibrant and sound financial system can
be built-up and sustained.




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BIBLIOGRAPHY


 1) “INDIAN BANKING” By R. Parameswaran.

 2) “CREDIT AND BANKING” By K.C. Nanda.

 3) “ECONOMIC DEVELOPMENT IN INDIA.” (Various issues)

 4) “PROFESSIONAL BANKER” (Sep 02, Mar 03.)

 5) “TREASURY MANAGEMENT” (Jan 03)

 6) “ANALYST” (Oct 02, Mar 03)

 7) Text of address by Deputy Governor (Shri G.P.Muniappan) at

   CII Banking Summit 2002 at Mumbai on April 1, 2002




WEBSITES

 1) www.indiainfoline.com.

 2) www.financialexpress.com.

 3) www.eastindiavyapaar.com.

 4) www.economictimes.com.




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