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Non Performing Advances

Prepared By: P N D Gomes

Sri Lanka
Unit No Page No.

1. Introduction 3

2. Background for the Study 4,5

2.1. The Problem
2.2. Objective of the Study
2.3. Scope
2.4. Hypothesis
2.5. Data
2.6. Sample

3. Technical view on NPAs 6,7

4. Pre Sanction Process 8

5. Macro & Micro Level factors 9 , 10

6. Statistical Information 11

7. Bank Growth Vs NPAs 12

8. NPAs impact on Economy 13

9. Practical Approach to Manage NPAs 14

10. Project Summary 15

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Banking system is the

lifeline of any economy.
State of health in the
banking sector is very
vital since it has a direct
impact on the economy.
Non performing advances
in banks books deteriorate
the state of health of the
banking sectors.

Unit 2

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Background for the Study

2.1. The Problem

Impact of Non Performing Advances for a bank is in several ways. It is not only bank
loose interest income on these advances, but it incurs cost to maintain those NPAs in the
bank portfolio. Banks have to maintain provisions ,incur legal expenditure other
miscellaneous charges on account of NPAs.The impact of NPAs results in lower interest
rates for depositors, higher interest rate for borrowers , capital write offs, less return to
share holders etc…..

NPAs hit the economic conditions of a country in several ways. In proper utilization of
borrowed money will not generate any positive results to boost the economic conditions,
failure of businesses will create unemployment, high inflationary rate etc…

2.2. Objective of the Study

Objective of this study is to identify the importance of managing NPAs and ways of
managing in order to have stability in the banking industry.

2.3. Scope

In this report on management of Non Performing Advances, activities starting form pre
sanction to post sanction, impact on the economy and Bank’s financial position and ways
of managing NPAs will be covered

2.4. Hypothesis

More effort is required in maintaining advances in performing rather than sanctioning

those. In other words more monitoring and supervision is required after sanctioning

2.5. Data

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Secondary Data was taken in compiling this project report.

Following are the sources of secondary data,

1. Central Bank releases

2. Banks Financial reports
3. Internet

2.6. Sample

Out of all commercial banks a leading private commercial bank with highest number of
branch network (among the private sector banks) was taken for the project study.

Unit 3

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Technical view on NPAs

Non Performing Advances

“An asset becomes Non Performing when it ceases to generate income for the bank”

As per the norms of the Central Bank of Sri Lanka, bank maintains five statues for
monitoring the performance of asset portfolio which are – Current, Overdue, Sub-
standard, Doubtful and Loss.

The above is applicable for all kinds of asset products. (Loans/Overdrafts/Bills)

Further Depending on the frequency of the loan recovery number of past due days will
differ. Following diagram 1 shows the Non Performing periods of loans with monthly
frequency and diagram 2 shows Non performing period for loans other than monthly
frequency, overdrafts, bills, etc….

Diagram 1

Asset classification is based on the DPD (days past due) counter for loan products with
monthly capital repayment frequency

DPD 1 – 60 days CURRENT

DPD 61 – 150 days OVERDUE
DPD 151 – 330 days SUBSTANDARD
DPD 331 – 510 days DOUBTFUL
DPD > 511days LOSS

Diagram 2

Asset classification is based on the DPD (days past due) counter for loan products other
than monthly capital repayment frequency and overdrafts

DPD 1 – 89 days CURRENT

DPD 90 – 179 days OVERDUE
DPD 180 – 359 days SUBSTANDARD
DPD 360 – 539 days DOUBTFUL
DPD > 540 days LOSS

All the 61/90 days overdue loans fall in the category of non-performing assets and are
eligible for provisioning once the loan becomes substandard onwards.

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Once the loan is outstanding for 61/90 days, it is marked as NPA and interest income is
suspended for last 61/90 days and when the loan becomes substandard and thereafter,
provisioning for net of the collateral value is being done by the bank.

Applicable provisioning % as follows

Sub-standard - Provisioning percentage is 20%

Doubtful - Provisioning percentage is 50%
Loss - Provisioning percentage is 100%

Unit 4

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Pre Sanction Process

All advances begin with the Credit Appraisal, where banks use different types of
appraising tools to ascertain the credit worthiness of the applicant.

Appraisal of a credit proposal requires a fluent understanding of credits with wealth of

past experience, ability to identifying risks, mitigating the risk and monitoring the risk.

Following were identified as ingredients behind quality credit appraisal

1. Credit staff should be well experienced and trained.

2. Credit staff should be well aware of banks credit policy
3. Risk assessment techniques should be in placed and updated.
4. Accessibility for out side information.(ex:industry,market)
5. Storage of historical data.(ex:Customers past records)
6. Discretionary powers should be given to officers at different levels depending on
the credit proposal.
7. Decision making process should be quicker.(Approval or rejection)
8. Adoption of new technology.

Even though above factors are in placed for sound lending advances will fall in to Non

Unit 5

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Macro & Micro Level factors

Macro Level Factors

Macro Level factors which leads to NPAs could be broadly categorizes under Political,
Economics, Social and Technological


Political interference in granting some advances deviating from basic credit principles
will end up with increasing NPAs. This is a very common factor in state own banks.


Changes in macro economic environment like inflation, high interest rates, depreciation
of currency, taxes, Industry barriers, Government policy changes etc….will result in
turning some lending of banks to Non Performing.
Rise in inflation, high interest rates will create new burden in meeting monthly
commitment. Depreciation of currency will impact on imports with upward movement on
prices. Other than that impose of taxes, change in fiscal policies to achieving political
objectives will also turn performing advances to bad.

Social Factors

Integrity of borrowers, ethics, values, education levels also influence the NPAs

Technological Factors

Adoption of latest technology also plays an important role in credit evaluation process.
Today in the banking sector sophisticated models are used in assessing and rating
borrowers. Non adoption of technology results in high cost of funds, delay in approval
process, missing of risk mitigating tools etc…. will influence the Non Performing

Micro Factors (Within the Bank)

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Biased Lending

When advances are granted with influence of officers in the approval process or at
management level not following basic credit principles, may result in Non Performing in

Achievement of Targets

Branch managers are set targets for lending and towards the year end if targets are not
met loans are sometime granted without through analysis.

Achievement of Profits

Branch managers grant facilities taking risks to meet profits targets compromising basics
of credits. Example: Temporary overdrafts are high risks but managers take the risk and
grant due to high interest income

Inadequate Credit Information

Complete information is required to do a proper credit evaluation (5C’s). It is a common

factor that even without available information loans are sanctioned. Some cases staff
carrying out the appraisal, when customer is unable to provide basic information gives
alternative suggestions in order to process the appraisal.


Lack of integrity in bankers also influenced the Non Performing portfolio.

Ex: Making decisions for financial rewards

Unit 6

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Statistical Information
Following diagrams show Gross NPA and Net NPA Ratio of Licensed Commercial
Banks for the period between 1998 and Up to March 2009
















20 7

ar **










***Gross Non-Performing Advances Ratio, % (Net of Interest in Suspense)

***Net Non-Performing Advances Ratio, % (Net of Interest in Suspense and
Unit 7

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Bank Growth Vs NPAs
Following were identified as major impacts of NPAs on Banks Growth/Stability

1. Deterioration of Profits

When an advance become NPA Interest due for last 3 month and future accruals
are required to transfer in to interest in suspense.

2. Increase in Provisions

When a loan or overdraft falls in to substandard category it is required to provide

capital provisioning.

3. Drop in Reserves

When a facility is not recoverable capital will be write off at last. This will have
an impact on Profits

4. Impact on Capital Adequacy

Banks will have an issue in meeting specified Tear 1 & Tier 11 requirements.

5. Increasing Overhead Costs

It is costly to maintain non performing advances, since it doesn’t generate an

income. (Ex: follow up costs, staff costs, legal costs)

6. Increasing Market Borrowings

When advances are not recoverable there fill be a liquidity issue in meeting
payments and granting further credit.Inorder to finance banks tend to borrow from
the market at high rate.

7. Drop in Share Value

When it is known a bank is having a high Gross NPA ratio and Net NPA ratio
share value will be dropped.

8. Negative Image

In the long run bank will have a negative image due to NPAs.

Unit 8

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NPAs impact on Economy

1. High Interest rates

In order to compensate the loss of interest in NPAs banks have to charged high
interest rate from other borrowers.this will have an indirect impact on inflation.

2. Negative Impact on development

When funds to lend become scare due to NPAs country’s development will get

3. Unemployment

Businesses ceased to exist due to inability to meet its repayment obligations. This
will create unemployment.

4. Instability in the banking system

Due to high NPA position if liquidity crisis arises and bail out is required, this has
huge impact on whole banking sector

Unit 9
Practical Approach to Manage NPAs

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At the later part of the Project study question was asked from selected branch mangers
and credit officers of the bank to establish suggestions to Managing NPAs.

Following are the summarized suggestions,

1. Improving the Appraisal system

Emphasis should be given to appraisal process to ensure proper evaluation done to

establish the credit worthiness of the customer. It should be noted at the appraisal
level all required information to submit in order for the approving authorities to
take a credit decision.

2. Continuous Monitoring supervision and follow up.

Monitoring supervision and Follow-up should not be a task to be implemented

when an advance turn in to loss category. Early warning signals should be
identified and preventive measures should be implemented

3. Availability of historical data

Availability of historical data is paramount of important in preparation of a credit

proposal. So banks should have historical data base to extract past records as and
when required.

4. Market Intelligence system

MIS information should be available for various reasons when taking credit
decisions. Ex: To rate a customer, to extract performance ratios

5. Speedy legal actions

When all possible attempts for recovery is failed only option is to proceed with
legal action and this should be speedy otherwise this will be costly.

6. Integrity

Staff integrity is also vital factors. No member in the approval cycle should take a
decision based on financial rewards.

7. Rewarding staff

Introducing a staff rewarding/incentive scheme will also support in reducing

NPAs. It should be noted rewarding staff will be less costly rather than spending.

Unit 10

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Project Summary

It is the duty of the Senior management, Middle management and down the line all staff
involved in credit to ensure a quality advance portfolio. When processing appraisals all
must adhere to basic credit principles without deviating. Proper training should be given
to staff either internally or externally and bank should ensure it has experienced staff to
handle credit.Ethics and Values should be observed by all staff handling credits. Timely
monitory follow-up and supervision is required and customer should be contacted
promptly when any early warning signal is identified. Further message should be clear to
borrowers that they can’t default and be free since they are accountable for the money

Finally NPAs should treated as most critical factor for banks survival. It is not possible to
get away from NPAs. But should be Managed Properly.

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