A STUDY OF NON PERFORMING ASSETS (NPA’S) – A

PROFIT CUTTER TO BANKING STRUCTURE

Dilip Guptaa and Dr. Sangeeta Guptab
a
Research Scholar, ABST Dept. Rajasthan University. Jaipur
b
Assisatant Professor, ABST Dept. Rajasthan University, Jaipur

ABSTRACT: Non Performing Asset (NPA’s) perhaps a big economical issue for all
developing countries including india, specially in recent years when kingfisher airlines turns
to be insolvent and promoters runaway leaving behind a huge amount unpaid on banking
system. Probably the above incidence is the one which actually gain attention of a common
man towards Non performing Asset and bankers, economist and government started giving
serious consideration to NPA management. NPA is like a double edge sword which attacks
from 2 sides. One NPA accounts are those advances which do not generate any income, on
the other hand banks need to create provision for the same as well as spent a considerable
amount on recovery measure. There are many research conducted on the topic of Non
Performing Assets (NPA) management, considering particular bank or Banks, comparative
study of public Banks, Private Banks or Foreign Banks etc. This Research paper attempts to
define out the meaning of Non Performing Assets, types of NPA, Their Classification,
Reasons of NPA, and Measures required for NPA Management.

Keywords: Non Performing Assets (NPA), Banks, Reasons, Measures.

1. Introduction:
The India, one of the fast developing countries in Asia continental and on the map of the world.
As for any developing economy the Banking Structure is basic pillar. India also has large
Banking Structure that covers not only urban areas but almost 40% to 45% of Rural area.
However still the largest portion is not covered under the Banking Structure.
Presently, there are four types of banking institutions in India. These are:
 Commercial banks, that includes Public Sector Banks and Private Banks.
 Regional rural banks
 Co-operative banks
 Development banks or 'term-lending institution'
RBI acts as the Central Bank of the country.

Banks Engages primarily in two functions viz. Accepting deposits from public and lending the
money to public. Lending is the functions that provides Income source to Banks through which
they meet their expenses and pays interest credits to their deposit holders. However the major
concern and problem area to bank is Losses that occurs due to heavy NPA’s (Non Performing
Assets) in Advances, which curtails Maximum portion of the Income of the Banks. A strong
banking sector is important for flourishing economy. The failure of the banking sector may have
an adverse impact on other sectors. Non-performing assets (NPA) are one of the major concerns
for banks in India.

The total NPA of all scheduled commercial banks in India had swollen from Rs. 47,300 crores
to Rs. 70,904 crores during the five years from March 1997 to March 2002, as per the Reserve
Bank's annual reports on trends and progress of banks in India. Against these, banks had
provided for Rs. 35,358 crores or roughly half the total by 2002. Still, the net NPA was as high
as Rs. 35,546 crores and represented 5.5 per cent of the total advances; this is high compared to
around 2 per cent for banks in advanced countries.

Through this article we tried to find out the reasons of heavy NPA’s and the suggestion to
reduce the Heavy NPA’s.

2. What is NPA?
Non Performing Asset means an asset or account of borrower, which has been classified by a
bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the
directions or guidelines issued by RBI.
According to RBI guidelines, an account shall be classified as NPA as per the below mentioned
criteria:
 Type of Loan Overdue period required to convert the Debt into NPA
Term Loan Interest and/or principal remain overdue for a period of more than 90
days
Overdraft/ Remains 'out of order' for a period of more than 90 days i.e. either no
Cash Credit credit to the Account (in case of overdraft) or Outstanding balance
exceeds the sanctioned limit (in case of Cash Credit) for continuous
period of 90 days
Bills Bill remains overdue for a period of more than 90 days
purchased and
discounted
Agricultural - For short duration Crops: Interest and/or principal remains overdue
Advances for two harvest seasons or crop season
- For long duration Crops: overdue Period is one harvest or crop
season
Here Long Duration Crops means where crop season is longer than 1
year. A crop which is not a long duration Crop is a short duration
Crop.
Securitisation Amount of Liquidity Facility remains outstanding for more than 90
Transaction days
Derivative Overdue receivables representing positive mark to market value of a
Transaction derivative contract remains unpaid for a period of 90 days from the
specified date for payment
Any other Any amount to be received, remains overdue for a period of more
than 90 days
Further Classification of Advances:
Performing Standard This does not disclose any problems and does not carry more
Assets (PA) assets than normal risk. (i.e. any Asset other than NPA)
Non Sub- Classified as NPA for a period not exceeding 12 months.
Performin standard
g Assets asset
(NPA) Doubtful Remained NPA for a period exceeding 12 months, but not
assets determined as loss asset by bank or internal auditor.
Loss assets Where loss has been identified by bank or by the internal or
external auditors or by the RBI Inspection, but the amount
has not been written off, wholly or partly

In India, the banking industry has undergone a sea change after the first phase of economic
liberalization in 1991 and hence credit management. While the primary function of banks is to
lend funds as loans to various sectors such as agriculture, industry, personal loans, housing loans
etc., in recent times the banks have become very cautious in extending loans, this is due to
mounting nonperforming assets (NPAs).
The banks are lending money to get revenue through interest rates along with principal. But
NPA has a bad effect on bank revenue. Therefore, an NPA account not only reduces profitability
of banks by provisioning in the profit and loss account, but their carrying cost is also increased
which results in excess & avoidable management attention. Non-performing loans epitomize bad
investment. They misallocate credit from good projects, which do not receive funding, to failed
projects. Apart from this, a high level of NPA also puts strain on banks net worth because banks
are under pressure to maintain a desired level of Capital Adequacy and in the absence of
comfortable profit level, banks eventually look towards their internal financial strength to fulfill
the norms thereby slowly eroding the net worth. The NPA are considered as an important
parameter to judge the performance and financial health of banks. If a bank has high NPA ratio
then its performance is considered as weak than that of a bank with lower NPA ratio. It creates a
bad effect on good will and equity value of the bank.
Considering all the above facts banking industry has to give more importance to NPA and to
structure proper remedial solutions.

3. Reasons for An Asset Turning NPA

One of the primary reasons for NPA could be that the lending decision was, ab initio, incorrect.
Seasoned bankers would scoff at this as a preposterous statement, but the reality has to be faced.
A major portion of bank lending is to industries and trade; this segment accounted for over 53
per cent of gross bank credit, excluding loans to food procurement agencies of governments, as
at the end of March 2002, vide RBI data.
A major portion of bad debts arose out of lending to the priority sector, at the dictates of
politicians and bureaucrats. If only banks had monitored their loans effectively, the bad debt
problem could have been contained, if not eliminated.
However in general The causes of NPA includes lack of proper pre-enquiry by the bank for
sanctioning loan to a customer, non performance of the business or the purpose for which the
loan has taken, some willful defaulters, fraud, loans sanctioned for agricultural purposes,
sluggish legal system, change in government policies. The reason were generally classified into
two
1. Overhand component – due to environmental reasons, business cycle etc
2. Incremental component – due to internal bank management, credit policy, term of credit etc.
There are various other reasons either jointly or singly responsible for an asset becoming NPA
can be classified as follows:-
(A) Reasons from the economic side
1. Political: Mindset regarding paradigm, proactive, fiscal responsible, major portion of
NPA arise out of lending to priority sector at the dictates of politicians and bureaucrats.
2. Economic: Growth, distribution, efficient allocation of resource.
 3. Social: Acceptability, mobility, education.
4. Technological: Lack of adoption of IT makes data processing difficult.
5. Legal: loan contracts are not enforceable naturally be a tendency to default.
6. Environmental: Liberalization and globalization.
(B) Reasons from the industry side
1. Global competition.
2. Cyclical downswing.
3. Sunset industry – industry growing slowly or declining.
4. Frequent changes in regulatory norms.
(C) Reasons from the borrower side
1. Misconceived project.
2. Poor governance.
3. Product failure.
4. Bungling management.
5. Diversion of fund.
6. Dormant capital structure.
7. Regulator changes.
(D) Reasons from the banking side
1. Parameter set for functioning was deficient.
2. Lack of freedom to choose product and pricing.
3. Unexposed to international marketing methods and products.
4. Wrong lending decision.
5. Lack of Resource and poor training.
6. Lack of system and procedure.
7. Lack of ability to handle assets and liability.
8. Lack of mechanism of credit information dissemination.
9. Collateral based lending to idle assets.
10. Fixing of price and quantum of loans.
11. Lack of effective IT system and MIS.
(E) Reasons from the loan structuring side
1. High debt equity ratio.
2. Timing of raising equity.
3. Discrepancy between rate of interest charged and realistic rate of return.
4. Inconsistency between revenue generation and the loan repayment schedule.
5. Lack of binding penal clause and performance guarantees.
6. Rising interest rate.
(F) Reason from the security side: There is a tendency among bank and institution to depend
excessively on collateral for advancing loans. It is important to presume that if the
borrower default in repaying then the security given will be helpful for recovery of loan.
 Clearly this logic is unacceptable. Emphasis should be on cash generation and a charge on
this should be built into the loan contract through some escrow mechanism.
(G) Reason from the regulatory side: Frequently regulator changes can turn assets non
performing. Accounting reason like reduction in income recognition norms from 180 days
to 90 days could be one reason and political relate dissues could be the other reason.
(H) Low level of expertise: Another factor that can contribute to the low level of expertise in
many big public sector banks is the constant rotation of duties among officers and the
apparent lack of training in lending principles for the loan officers. Being dictated to by the
bureaucrats in the Government, public sector banks are asked to frown upon specialisation
of officers in any particular branch of banking; this also makes it hard for developing a
fully trained cadre of lending officers.

4. Solutions to Come Out From Problem of NPA

(A) Restructuring of finance: Bank has to increases the number of installment by minimizing
the quantum of installment in order to recover the loan. Restructuring may be at following
stages:
(a) Before commencement of commercial production,
(b) After commencement of commercial production but before the asset has been
classified as sub-standard;
(c) After commencement of commercial production and the asset has been classified as
sub-standard.
In Rescheduling of principal and/or interest, there could be 'sacrifice' on part of the banks.
Reschedulement of installments of only principal amount at first two stages would not
cause a standard asset to be classified in the sub-standard provided the loan/credit facility
is fully secured. Even the Reschedulement of the interest at first two stages would not
cause the standard asset to be classified as sub-standard, if the sacrifice of interest
measured in present value term is either written off or fully provided.
In case of Reschedulement/Refixation of terms of loan after classification of asset as sub-
standard the asset would be continued to be classified in the same category if the
loan/credit facility is fully secured. Where there is sacrifice of interest, the same would
have to be written off or provided for. Sub-standard accounts subjected to restructuring
can be upgraded to standard category only after a period of one year from the date of first
payment of interest or principal as per rescheduled term subject to satisfactory
performance during the period. On such up-gradation, the provision made earlier can be
reversed after taking into account he interest sacrificed. If satisfactory performance of
such sub-standard account is not evident during the one-year period, from the date when
first installment become due the asset classification of restructured account would be
governed as per the applicable prudential norms with reference to the pre-Reschedulement
payment schedule.
(B) Industrial Reconstruction Bank of India (IRBI): IRBI was set up on 20th March 1985,
by reconstituting the Industrial reconstruction corporation of India as the principal credit
and reconstruction agency for industrial revival and to coordinate similar work of the
other institution engaged there in and to assist and promote industrial development and to
rehabilitate industrial concern.
(C) ARCs: ARCs purchase bad or non-performing loans, either of a company or an entire
portfolio, hoping to restructure the loan or sell the assets to make money. Similarly
Danaharata was established in Malaysia, Kamco in Korea and PT in Indonesia. Concerns
have been raised about their relevance to India. (Viswanathan, 2002)
(D) Lok Adalats: Lender and borrowers were brought face to face to negotiate a settlement.
(E) Debt Recovery Tribunal: It was set up under the recovery of debts due to banks and
Financial Intuitions Act, 1993 with exclusive jurisdiction to try and dispose of matters
pertaining to recovery of debts due to bank and financial assets. It has the potential of
playing a significant role in NPA realization.

(F) Corporate debt restructuring: Corporate debt restructuring mechanism was introduced
as a platform for handling large NPA, with a potential to give long term package of
financial and management restructuring. It rephrases the loan servicing obligation of the
borrower and some concession in the interest rate.
(G) SARFAEST Act: SAREAEST is the preferred route for finding solution to NPA when
compared to the other methods which were discussed above. There was no legal provision
for facilitating securitization of financial assets of bank and FIs or power to take
possession of securities and sell them. This resulted in slow recovery of defaulting loan
and mounting levels of NPA of bank and FIs and a need was felt for keeping pace with
changing commercial practice and financial sector reforms. Keeping with this an enabling
legislative and regulatory frame work was put in place with the enactment of the
securitization and Reconstruction of Financial assets and Enforcement of Security interest
Act,[Link] primary objective of act is reduction of NPA levels of banks/FIs and
unlocking value from distressed assets in the banking and financial system.
(H) Well Developed Capital Markets: Numerous papers have stressed the criticality of a
well developed capital market in the restructuring process. A capital market brings
liquidity and a mechanism for write off of loans. Without this a bank may seek to
postpone the NPA problem for fear of capital adequacy problems and resort to tactics like
ever greening. Monitoring by bondholders is better as they have no motive to sustain
uneconomic activity. Further, the banks can manage credit risk better as it is easier to sell
or securitize loans and negotiate credit derivatives. India debt market is relatively under
developed and attention should be focused on building liquidity and volumes. (Toshiki,
Kanomori, 2001)
 (I) Contextual Decision making: Regulations must incorporate a contextual perspective
(like temporary cash flow problems) and clients should be handled in a manner which
reflects true value of their assets and future potential to pay. The top management should
delegate authority and back the decisions of this kind taken by middle level managers.
(J) Legal Issues: There have been instances of banks extending credit to doubtful debtors
(who willfully default on debt) and getting kickbacks for the same. Ineffective Legal
mechanisms and inadequate internal control mechanisms have made this problem grow –
quick action has to be taken on both counts so that both the defaulters and the authorizing
officer are punished heavily. Without this, all the mechanisms suggested above may prove
to be ineffective. (Muniappan, 2002)
(K) Regular Training Program: Executives have to undergo regular training program on
credit and NPA management. It is very useful and helpful to the executives for dealing the
NPAs properly.
(L) Recovery camps: The banks should conduct regular or periodical recovery camps in the
bank premises or some other place, such type of recovery camps reduced the levels of
NPA in the banks
(M) Spot Visit: The bank officials should visit to the borrower’s business place / borrowers
field regularly or periodically.
(N) Other Methods: such as Persistent phone calls or Media announcement.

5. PROVISIONING FOR LOANS AND ADVANCES:

Banks are also require to make provision on the Advances as one of the Prudential Norms
requirement. This is required to ensure that Losses arising due to NPA is not shown as loss of
one years rather shall be spread over to number of years. Provision to be made is as follows -
(A) Loss assets: Should be written off or 100% provision should be made for the amount
outstanding.
(B) Doubtful assets:
(i) Full provision to the extent of the unsecured portion should be made. The R.V. of the
security available should be determined on realistic basis.
(ii) In regard to the secured portion, no provision needs to be made towards the
guaranteed portion by DICGC (Deposit Insurance And Credit Guarantee Corporation)
or ECGC (Export Credit Guarantee Corporation). over & above guaranteed portion
should be provided for as per the period for which asset has remained doubtful:

Period for which Advance has been considered as doubtful % of

Provision
Up to 1 years 25
More than 1 year and up to 3 years 40
More than 3 years 100
 (C) Sub-standard assets: 15%* on total outstanding should without making any allowance
for DICGC/ECGC cover and securities available. An additional provision of 10% is
required to be made on 'unsecured exposure'. (However “Unsecured Exposure” in respect
of infrastructure Loan Accounts classified as Substandard, in case of which certain
safeguards are available will attract only additional provision of 5%).
Unsecured exposure is defined as 'an exposure where the realizable value of security is not
more than 10% of the outstanding exposure (fund based and non-fund based).
(D) Standard assets: General provision of a minimum of 0.40% of total standard asset should
be made, but for Agriculture and SME sector the rate is .25%.
However the basis reason of becoming NPA is not any one. The combination and packet of
problems has made the NPA problem much bigger then it would have been if those other factors
had not existed. However adaptation of various corrective measures as suggested above and
prudential norms guided by RBI will definitely help to reduce the level of NPA.

6. Conclusion:
Various Reasons for generation of NPA has been discussed in detail. Further the measures
required for reducing NPA’s has also been discussed. The Analysis shows that there is not only
one factor that contributes in generation of NPA. The multiple effect of all factors including
social factors works together. However the major weaker portion is on part of banks
management such as lacking of proper internal control system for evaluation of creditworthiness
of borrower, sanctioning to risky projects and lack of proper recovery mechanism. Non
evaluation of position of borrower on regular basis is another factor. However various measures
on part of banks such as restructuring of Advances, Corporate Debt Restructuring, recovery
camps etc. and on part of Government such as SARFAESI Act, 2002, Lok Adalats, Debt
Recovery Tribunal etc. helping prominently in reducing the size of NPA’s and gearing up the
process of recovery from defaulted accounts. Indian Banks are still not ready for affording huge
NPA’s. Hence Management of Indian Banks shall pay special attention towards NPA
management. Timely action on part of government and introducing new legislations are also
required.

7. References
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University Press, New Delhi.
(b) [Link], No.1, March 2005, pp 22-27.
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(e) Jansen, D & Baye, M (1999): ‘Money, Banking & Financial Markets –An Economics
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(f) McGoven, J (1998): ‘Why Bad Loans happen to Good Banks’, The Journal Of Commercial
Lending, Philadelphia, February 1998, Vol.78.
(g) Dr. Kamal Garg, Advance Auditing and Practices, Topic “Audit of Banks”.
(h) Mohan, R (2011): ‘Transforming Indian Banking – In search of a better tomorrow’, Reserve
Bank of India Bulletin, January
(i) ----------(2013): ‘Finance for Industrial Growth’, Reserve Bank of India Bulletin, March.
(j) Muniappan, G (2002): ‘The NPA Overhang Magnitude , Solution and Legal Reforms’,
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