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What is NPA

What is NPA

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Published by: bhagatamit on Nov 01, 2010
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10/24/2012

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What is NPA?:
Banking businesses is mainly that of borrowing from the public and lendingit to the needy persons and business at a premium. Lending of money involves a credit risk.When the loans and advances made by banks or financial institutions turnout as non - productive, non-rewarding and non - remunerative then they will become Non ± PerformingAssets (NPA). NPA is an asset or account of a borrower, which is classified by a bank or financial institution as sub-standard asset, doubtful assetand loss asset .The NPA were to be reckoned on past due basis prior to 31.3.2001. As per the guidelines if the amount remained past due for more than two quarters it is treated as NPA. When theadvance remains outstanding for 30 days beyond the due date it is past due as per RBIclassification issued in December 1992. (!) Out of order means outstanding balance in theoverdraft / cash credit account which remains continuously in excess of the sanctioned limitfor 6 months. If the outstanding balance in principal Over draft and Cash credit is less thanthe sanctioned limit but there is no credit balance for 6 months or balance is not enough tocover interest debited for the period, then such account is also to be taken as out of order.Over the years the criteria for NPA regulations have become stricter. RBI reports said thatthese stricter guidelines are issued for improvements in the payment and settlementsystems, recovery climate and up gradation of technology in the banking system.Factors Contributing NPAs: The factors contributing to NPAs are:1. Diversification of funds for expansion, modernization undertaking of new projects andalso for helping associate concerns. This is coupled with recessionary trends and failure to taprequired funds in the capital and debt market.2. Business (Product, marketing, financial) failure, inefficient management, strained labor relations, inappropriate technology, outmoded machinery, technical problems and productobsolescence.3. Recession, input and power shortage, price escalation, accidents, natural calamities,external problems in other countries leading to non ±  payment of over dues.4. Time and cost over run during project implementation stage.5. Government policies like changes in excise duties, pollution control, poor credit decisions, priority sector lending and outdated legal systems.6. Willful default, siphoning off funds, fraud and misappropriation by promoters anddirectors dispute.7. Deficiencies on the part of banks like delay in release of funds and delay in release of subsidies by government.8. Delay in finalization of rehabilitation package by the board of Industrial andReconstruction (BIFR).9. Absence of written policies.10. The absence of portfolio concentration limits, poor industry analysis, cursory financialanalysis of borrowers.11. Inadequate customers contract12. Excessive reliance on collateral, absence of follow up action by banks, poor control onloan documentation.13. Absence of asset classification and loan loss provisioning standards and14. The lack of co-ordination between the financial institutions and commercial banks,which provide long-term needs of industry that, enables the industry to misuse the funds.
 
Imp
act of NPAs on Banking O
per
ations:
The efficiency of a bank is not reflected only by the size of its balance sheet but also the levelof return on its assets. The NPAs do not generate interest income for banks but at the sametime banks are required to provide provisions for NPAs from their current profits. The NPAshave deleterious impact on the return on assets in the following ways.The interest income of banks will fall and it is to be accounted only on receipt basis.1. Banks profitability is affected adversely because of the providing of doubtful debts andconsequent to writing it off as bad debts.2. Return on investments (ROI) is reduced.3. The capital adequacy ratio is disturbed as NPAs are entering into its calculation.4. The cost of capital will go up.5. The assets and liability mismatch will widen.6. The economic value addition (EVA) by banks gets upset because EVA is equal to the netoperating profit minus cost of capital and7. It limits recycling of the funds.It is due to above factors the public sector banks are faced with bulging NPAs which resultsin lower income and higher provisioning for doubtful debts and it will make a dent in their  profit margin. In this context of crippling effect on banks operation the slew asset quality is placed as one of the most important parameters in the measurement of banks performanceunder the Camel¶s supervisory rating system of RBI.
M
e
asu
re
s to Cont
r
ol NPAs M
e
nac
e
:
It is proved beyond doubt that NPAs in bank ought to be kept at the lowest level. Two pronged approaches viz.1.
 
Preventive management and2.
 
Curative management would be necessary for controlling NPAs.
P
reve
nti
ve
Manag
eme
nt:C
red
it Ass
e
ss
me
nt an
d
Risk Manag
eme
nt M
e
chanis
m
:
A lasting solution to the problemof NPAs can be achieved only with proper credit assessment and risk managementmechanism. The documentation of credit policy and credit audit immediately after thesanction is necessary to upgrade the quality of credit appraisal in banks. In a situation of liquidity overhang the enthusiasm of the banking system is to increase lending withcompromise on asset quality, raising concern about adverse selection and potential danger of addition to the NPAs stock. It is necessary that the banking system is equipped with prudential norms to minimize if not completely avoid the problem of credit risk.
O
r
ganisational
e
st
r
uctu
r
ing:
With regard to internal factors leading to NPAs the onus for containing the same rest with the bank themselves. These will necessities organizationalrestructuring improvement in the managerial efficiency, skill up gradation for proper assessment of credit worthiness and a change in the attitude of the banks towards legal action,which is traditionally viewed as a measure of the last resort.
ed
uc
e
D
epe
n
de
nc
e
on
I
nt
ere
st:
The Indian banks are largely depending upon lending andinvestments. The banks in the developed countries do not depend upon this income whereas86 percent of income of Indian banks is accounted from interest and the rest of the income isfee based. The banker can earn sufficient net margin by investing in safer securities though
 
not at high rate of interest. It facilitates for limiting of high level of NPAs gradually. It is possible that average yield on loans and advances net default provisions and services costs donot exceed the average yield on safety securities because of the absence of risk and servicecost.
Pot
e
ntial an
d
Bo
rder
lin
e
N
p
as un
der
Ch
e
ck:
The potential and borderline accounts requirequick diagnosis and remedial measures so that they do not step into NPAs categories. Theauditors of the banking companies must monitor all outstanding accounts in respect of accounts enjoying credit limits beyond cut ± off points, so that new sub-standard assets can be kept under check.
Cu
r
ati
ve
Manag
eme
nt:
The curative measures are designed to maximize recoveries so that banks funds locked up in NPAs are released for recycling. The Central government and RBIhave taken steps for arresting incidence of fresh NPAs and creating legal and regulatoryenvironment to facilitate the recovery of existing NPAs of banks. They are:
D
eb
t R 
e
co
very
T
r
i
b
unals (DRT):
In order to expedite speedy disposal of high value claimsof banks Debt Recovery Tribunals were setup. The Central Government has amended therecovery of debts due to banks and financial institutions Act in January 2000 for enhancingthe effectiveness of DRTs. The provisions for placement of more than one recovery officer, power to attach dependents property before judgment, penal provision for disobedience of Tribunals order and appointment of receiver with powers of realization, management, protection and preservation of property are expected to provide necessary teeth to the DRTsand speed up the recovery of NPAs in times to come.
Lok A
d
alats:
The Lok adalats institutions help banks to settle disputes involving accounts indoubtful and loss categories. These are proved to be an effective institution for settlement of dues in respect of smaller loans. The Lok adalats and Debt Recovery Tribunals have beenempowered to organize Lok adalats to decide for NPAs of Rs. 10 lakhs and above.
Ass
e
t
e
const
r
uction Co
mp
an
y
(ARC):
The Narasimham Committee on financial system(1991) has recommended for setting up of Asset Reconstruction Funds (ARF). The followingconcerns were expressed by the committee.1. It was felt that centralized all India fund will severely handicap in its recovery efforts bylack of widespread geographical reach which individual bank posses and.2. Given the large fiscal deficits, there will be a problem of financing the ARF.Subsequently, the Narasimham committee on banking sector reforms[5] hasrecommended for transfer of sticky assets of banks to the ARC. Thereafter the Varmacommittee on restructuring weak public sector banks has also viewed the separation of NPAsand its transfer thereafter to the ARF is an important element in a comprehensiverestructuring strategy for weak banks. In recognition of the same ARC Bill was passed toregulate Securitization and Reconstruction of financial assets and enforcement of securityinterest. The ICICI BANK, State Bank of India and IDBI have promoted the country¶s firstAsset Reconstruction Company. The company is specialized in recovery and liquidation of assets. The NPAs can be assigned to ARC by banks at a discounted price. The objective of ARC is floating of bonds and making necessary steps for recovery of NPAs from the borrowers directly. This enables a one time clearing of balance sheet of banks by stickyloans.

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