Analysis of NPA Management

A Dissertation Report
On
Analysis of NPA Management with Special Reference to South
Indian Bank
Submitted in partial fulfillment of the requirement for the award of
the degree
of
Master of Business Administration
Of
Bangalore University
By

Anupama Narayanan
Reg. No: 07XQCM6010

Under the guidance and supervision of
Prof. Praveen Bhagawan

M. P. BIRLA INSTITUTE OF MANAGEMENT
Associate Bharatiya Vidya Bhavan
#43, Race Course Road, BANGALORE-560001
MPBIRLAINSTITUTEOFMANAGEMENT Page1

2009

DECLARATION

I, hereby, declare that this research report entitled Analysis of
NPA Management with Special Reference to SOUTH INDIAN BANK
submitted in partial fulfillment for the award of Master of Business
Administration of Bangalore University is a record of independent
work carried out by me under the guidance of Prof. Praveen
Bhagawan (Faculty member), M. P. Birla Institute of Management
Studies, Bangalore.
I, also declare that this report is a result of my own effort and has
not been submitted earlier for the award of any degree or
diploma of Bangalore University or any other University.

Place: Bangalore (Anupama Narayanan)
Date: - REGD.NO. 07XQCM6010


ACKNOWLEDGEMENT

The attitude bliss and emphasis that accompanies the successful
completion of my task would be incomplete without the
expression of appreciation towards those who helped me colour
the mosaic of this project with the tiles of their knowledge,
expertise, experience and co-operation.
I extend my special thanks to my Respected Guide, Prof. Praveen
Bhagawan who has motivated and inspired me throughout my
project work with his timely guidance, help, support and
supervision.

I am extremely grateful to Dr. N. S. Malavalli for his help and
support and for giving me an opportunity to complete my project.

I also would like to thank all executive of South Indian Bank who
helped me providing data and information to complete my
project.

Anupama Narayanan


EXECUTIVE SUMMARY
The most important problem that the Indian banks are facing is the problem of their
NPAs. It is only since a couple of years that this particular aspect has been given so
much importance. The banks have to overcome these difficulties properly in order to
effectively counter the competition faced by the foreign banks. With the framing of
laws as per international standards and setting up of Debt recovery tribunal we can
say that steps have been taken in this direction.
Banks in India have traditionally been saddled with very high Non-Performing Assets.
The banking sector was heading for a crisis in 2001 with NPAs crossing a mammoth
64000 crores. Banks burdened with huge NPAs faced uphill tasks in recovering then
due to archaic laws and procedures. Realizing the gravity of the situation the
government was quick to implement the recommendations of the Narsimham
Committee and Andhuarjuna Committee leading to the enactment of the SARFAESI
ACT 2002.( Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act).
This Act gave the banks the much needed teeth to curb the menace of NPAs. The
non performing assets (NPAs) of banks have at last begun shrinking. As reported from
surveys, it is understood that there has been substantial improvements in non
performing assets and this has been because of several measures such as formation
of asset reconstruction companies, debt restructuring norms, securitization,
provisioning norms and prudential norms for income recognition. The gross NPAs of
the banking system are about 16 per cent of the total assets of the nationalized
banks as of 2000-01. This is against a global norm of about 5%. Hence there is a long
way to go before we can say that the NPAs of our banks are under control. The
improvements in NPAs of individual nationalized banks have been in the order of
10% to 20%, thanks to the various schemes and measures introduced. This paper
addresses the results we have achieved so far since the measures have been
implemented and the thrust on measures that need to be taken to expedite
recovery of NPAs. We also give our suggestions as to how NPA retrieval can be
made easy and in what way the NPA scenario is headed.

The problem is no doubt about recovery management where the objective is to find
out about the reasons behind NPAs and to create networks for recovery. Four Banks
have been randomly picked up and compared with South Indian Bank. The deposit
growth loan growth, cost income ratio of these banks have been compared and
analysed.
RESEARCH ABSTRACT
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 are one of the major concerns for banks in India.
NPAs reflect the performance of banks. A high level of NPAs suggests high
probability of a large number of credit defaults that affect the profitability and net-
worth of banks and also erodes the value of the asset. The NPA growth involves the
necessity of provisions, which reduces the over all profits and shareholders value.
The issue of Non Performing Assets has been discussed at length for financial system
all over the world. The problem of NPAs is not only affecting the banks but also the
whole economy. In fact high level of NPAs in Indian banks is nothing but a reflection
of the state of health of the industry and trade.
This report deals with understanding the concept of NPAs, its magnitude and major
causes for an account becoming non-performing, projection with special reference
to SOUTH INDIAN BANK.


TABLE OF CONTENT

SR.NO. PARTICULAR
THEORETICAL BACKGROUND
1.1 INTRODUCTION
1.2 BACKGROUND
1.3 NPA MANAGEMENT BIGGEST CHALLENGE
FOR BANK IN 2009
1.4 NPA IN INDIA- CURRENT SCENARIO
RESEARCH DESIGN
2.1 NEED OF STUDY
2.2 RESEARCH OBJECTIVE
2.3 RESEARCH METHODOLOGY
2.4 DATA COLLECTION
2.5 SAMPLING UNIT
2.6 LITERATURE REVIEW
INDUSTRY PROFILE
3.1 THE TRANSFORMATION OF INDIAN BANKING INDUSTRY
3.2 THE TASK AHEAD
3.3 CHALLENGES FACING BANKING INDUSTRY IN INDIA
3.4 NPA
3.5 FACTOR FOR RISE IN NPAS
3.6 PROBLEMS DUE TO NPA
3.7 WHAT CAUSED SUCH HIGH NPAS IN SYSTEM UNTIL 1995
3.8 WHAT CHANGED THE SCENARIO OF NPAS AFTER 1995
4.1 COMPANY PROFILE
DATA ANALYSIS & INTERPRETATION
5.1 FINANCIAL OF SOUTH INDIAN BANK
5.2 OPERATIONAL REVIEW
5.3 FINANCIAL RESULT 2008-09
5.4 COMPARISON
5.5 BASEL REPORT FRAMEWORK AND INDIA
5.6 BANKING REGULATION AND FRAMEWORK
5.7 THE BASEL I ACCORD
5.8 CONCLUSION AND SUGGESTION

LIST OF FIGURES AND CHART

SR.NO. PARTICULARS
1 GNNP,NNPA and credit growth over the years
2 Operating expenses/total assets ratio
3 Credit growth over the years
4 Gross NPA in banking system
5 Current shareholding of CIBIL
6 Gross NPA level for various banks
7 Deposits growth over 5 years
8 Unsecured loan as % of total loan
9 Cost income ratio


Chapter - 1
Introduction


1.1 Background of the study
The crucial role of bank economists in transforming the banking system in India. Economists
have to be more mainstreamed within the operational structure of commercial banks. Apart
from the traditional functioning of macro-scanning, the inter linkages between treasuries,
dealing rooms and trading rooms of banks need to be viewed not only with the day-to-day
needs of operational necessity, but also with analytical content and policy foresight. Banking
sector reforms in India has progressed promptly on aspects like interest rate deregulation,
reduction in statutory reserve requirements, prudential norms for interest rates, asset
classification, income recognition and provisioning. But it could not match the pace with
which it was expected to do. The accomplishment of these norms at the execution stages
without restructuring the banking sector as such is creating havoc.
During pre-nationalization period and after independence, the banking sector remained in
private hands Large industries who had their control in the management of the banks were
utilizing major portion of financial resources of the banking system and as a result low
priority was accorded to priority sectors. Government of India nationalized the banks to make
them as an instrument of economic and social change and the mandate given to the banks was
to expand their networks in rural areas and to give loans to priority sectors such as small scale
industries, self-employed groups, agriculture and schemes involving women.
To a certain extent the banking sector has achieved this mandate. Lead Bank Scheme enabled
the banking system to expand its network in a planned way and make available banking
series to the large number of population and touch every strata of society by extending credit
to their productive endeavors. This is evident from the fact that population per office of
commercial bank has come down from 66,000 in the year 1969 to 11,000 in 2004. Similarly,
share of advances of public sector banks to priority sector increased form 14.6% in 1969 to
44% of the net bank credit. The number of deposit accounts of the banking system increased
from over 3 Crores in 1969 to over 30 Crores. Borrowed accounts increased from 2.50 lakhs
to over 2.68 Crores. Without a sound and effective banking system in India it cannot have a
healthy economy.


The banking system of India should not only be hassle free but it should be able to meet new
challenges posed by the technology and any other external and internal factors. For the past
three decades India's banking system has several outstanding achievements to its credit. The
most striking is its extensive reach. It is no longer confined to only metropolitans or
cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners
of the country.
Granting of credit for economic activities is the prime duty of banking. Apart from raising
resources through fresh deposits, borrowings and recycling of funds received back from
borrowers constitute a major part of funding credit dispensation activity. Lending is generally
encouraged because it has the effect of funds being transferred from the system to productive
purposes, which results into economic growth. However lending also carries a risk called
credit risk, which arises from the failure of borrower. Non-recovery of loans along with
interest forms a major hurdle in the process of credit cycle. Thus, these loan losses affect the
banks profitability on a large scale. Though complete elimination of such losses is not
possible, but banks can always aim to keep the losses at low level. Non-performing Asset
(NPA) has emerged since over a decade as an alarming threat to the banking industry in our
country sending distressing signals on the sustainability and endurability of the affected
banks. The positive results of the chain of measures affected under banking reforms by the
Government of India and RBI in terms of the two Narasimhan Committee Reports in this
contemporary period have been neutralized by the ill effects of this surging threat. Despite
various correctional steps administered to solve and end this problem, concrete results are
eluding. It is a sweeping and all pervasive virus confronted universally on banking and
financial institutions
1.2 NPA management biggest challenge for banks in 2009
After the global financial turmoil in 2008, Indian banks begin the new year with a lurking
fear that their Non Performing Assets (NPA) would go up with their portfolios coming under
severe stress.

There is already a visible strain on consumer, credit card and vehicle loan portfolios and
many banks have taken conscious decision to scale down their advances to risky sectors.
Some banks have also revised their credit growth targets downwards as the year has come to
a close.
The ongoing financial crisis has had its toll on export-related sectors like IT, textile and
SMEs. This may indirectly impact banks asset quality. There is, therefore, a pressing need to
ensure adequate risk-management mechanisms to overcome this challenge, State-owned
Bank of Barodas (BoB) Chairman and Managing Director M D Mallya said.
Indian banks witnessed a sharp jump in their gross NPAs for the first time in six years in
FY08, compelling many of them to enhance their existing risk assessment tools.
Gross NPAs of commercial banks in FY08 escalated by Rs 6,136 crore, according to figures
released by the Reserve Bank. Though there was no need to be unduly alarmed, banks need to
follow certain standard parameters to ensure the quality of their lending portfolios, Mallya
said. Similar view was echoed by ICICI Banks CEO-elect Chanda Kochhar who said the
lender has taken a conscious decision to follow certain parameters to ensure asset quality.
Despite pressures emanating from global financial markets, Indian banks witnessed a healthy
25-29 per cent average growth in credit disbursals, primarily in housing, auto and
infrastructure loans.
IndusIand Banks Head of Wholesale Banking Group, J Moses Harding supported this view
saying that the present economic downturn has affected the repayment capacities of small
firms, exerting pressure on the banks lending portfolios. There is a pressure on SMEs as
many of them are unable to repay their advances in the current scenario. This situation is
likely to last in the short term. Banks need to adjust their risk management mechanisms to
face the situation, Harding said. Banks witnessed a huge credit demand from their corporate
clients who found their foreign funding sources drying up in the aftermath of the global
meltdown which originated with the subprime crisis in America in mid-2007.
The growth in credit in the industry in 2008 was in the range of 25-29 per cent on account of
working capital requirements of small-, mid- and large-size industries, and the bankers expect
an average 25 per cent rise in their credit in 2009. While state-owned banks were quick to
respond to the recent signals from policy-makers by reducing interest rates periodically,
many Private Sector Banks (PSB) are yet to follow the suit, mainly owing to pressure on their
margins.

1.3) NPAs in India - The Current Scenario
For the past few years, the Indian Banking system has been struggling to manage the vast
portfolio of bad loans, popularly known as Non-Performing Assets (NPAs). The problem is
more acute in the case of PSU banks. As of March 2003, the total NPAs of the private and
public sector banks put together stood at a whopping Rs 65,000 crore (Source: Trend and
Progress of Banking in India, RBI).
NPAs, simply defined, are those loans and advances in respect of which interest and/or
principal installment have not been paid for 180 days from the due date. From April 1, 2004,
however, any loan on which interest or principal installment is not paid for more than 90
days would be reckoned as NPA. The banking system is, therefore, sure to see a swelling
NPA portfolio in the coming years. This poses a serious liquidity and credit risk on the
banking system, which unless managed effectively would jeopardize the same.
Thus, to prevent the collapse of the whole system due to non-payment of loans by the
borrowers, there ought to be some mechanism in place. Two major steps were taken in this
regard -
1. The RBI directed the banks to maintain compulsory provisions for different types of
NPAs;
2. The Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002 was enacted.
The SARFAESI Act allowed the banks and financial institutions to take possession of the
collateral security given by the defaulting borrowers and sell these assets without having to
go through protracted legal procedures.

The financial sector reforms in the country were initiated in the beginning of the 1990s.The
reforms have brought about a sea change in the profile of the banking sector. Our
implementation of the reforms process has had several unique features. Our financial sector
reforms were undertaken early in the reform cycle. Notably, the reforms process was not
driven by any banking crisis, nor was it the outcome of any external support package.
Besides, the design of the reforms was crafted through domestic expertise, taking on board
the international experiences in this respect. The reforms were carefully sequenced with
respect to the instruments to be used and the objectives to be achieved. Thus, prudential
norms and supervisory strengthening were introduced early in the reform cycle, followed by
interest-rate deregulation and a gradual lowering of statutory preemptions. The more complex
aspects of legal and accounting measures were ushered in subsequently when the basic tenets
of the reforms were already in place.
The public sector banks continue to be a dominant part of the banking system. As on March
31, 2008, the PSBs accounted for 69.9 per cent of the aggregate assets and 72.7 per cent of
the aggregate advances of the Scheduled commercial banking system. A unique feature of the
reform of the public sector banks was the process of their financial restructuring. The banks
were recapitalized by the government to meet prudential norms through recapitalisation
bonds. The mechanism of hiving off bad loans to a separate government asset management
company was not considered appropriate in view of the moral hazard. The subsequent
divestment of equity and offer to private shareholders was undertaken through a public offer
and not by sale to strategic investors. Consequently, all the public sector banks, which issued
shares to private shareholders, have been listed on the exchanges and are subject to the same
disclosure and market discipline standards as other listed entities. To address the problem of
distressed assets, a mechanism has been has been developed to allow sale of these assets to
Asset Reconstruction Companies which operate as independent commercial entities.

As regard the prudential regulatory framework for the banking system, we have come a long
way from the administered interest rate regime to deregulated interest rates, from the system
of Health Codes for an eight-fold, judgmental loan classification to the prudential asset
classification based on objective criteria, from the concept of simple statutory minimum
capital and capital-deposit ratio to the risk-sensitive capital adequacy norms initially under
Basel I framework and now under the Basel II regime. There is much greater focus now on
improving the corporate governance set up through fit and proper criteria, on encouraging
integrated risk management systems in the banks and on promoting market discipline through
more transparent disclosure standards. The policy endeavor has all along been to benchmark
our regulatory norms with the international best practices, of course, keeping in view the
domestic imperatives and the country context. The consultative approach of the RBI in
formulating the prudential regulations has been the hallmark of the current regulatory regime
which enables taking account of a wide diversity of views on the issues at hand.
The implementation of reforms has had an all round salutary impact on the financial health of
the banking system, as evidenced by the significant improvements in a number of prudential
parameters.
Let me briefly highlight the improvements in a few salient financial indicators of the banking
system.
The average capital adequacy ratio for the scheduled commercial banks, which was around
two per cent in 1997, had increased to 13.08 per cent as on March 31, 2008. The
improvement in the capital adequacy ratio has come about despite significant growth in the
aggregate asset of the banking system. This level of capital ratio in the Indian banking system
compares quite well with the banking system in many other countries though the capital
adequacy of some of the banks in the developed countries has remained under considerable
strain in the recent past in the aftermath of the sub-prime crisis.
In regard to the asset quality also, the gross NPAs of the scheduled commercial banks, which
were as high as 15.7 per cent at end-March 1997, declined significantly to 2.4 per cent as at
end-March 2008. The net NPAs of these banks during the same period declined from 8.1 per
cent to 1.08 per cent. These figures too compare favourably with the international trends and
have been driven by the improvements in loan loss provisioning by the banks as also by the
improved recovery climate enabled by the legislative environment. What is noteworthy is that
the NPA ratios have recorded remarkable improvements despite progressive tightening of the
asset classification norms by the RBI over the years.
The reform measures have also resulted in an improvement in the profitability of banks. The
Return on Assets (RoA) of scheduled commercial banks increased from 0.4 per cent in the
year 1991-92 to 0.99 per cent in 2007-08. The Indian banks would appear well placed in this
regard too vis--vis the broad range of ROA for the international banks.

The banking sector reforms also emphasized the need to improve productivity of the banks
through appropriate rationalisation measures so as to reduce the operating cost and improve
the profitability. A variety of initiatives were taken by the banks, including adoption of
modern technology, which has resulted in improved productivity. The Business per
Employee (BPE), as a measure of productivity, for the public sector banks has registered
considerable improvement. The BPE for the public sector banks, which was Rs. 95 lakh in
1998-99, almost doubled to Rs. 188 lakh in 2002 and more than redoubled to Rs. 496 lakh in
2007. It needs to be noted that the turnaround in the financial performance of the public
sector banks, pursuant to the banking sector reforms, has resulted in the market valuation of
government holdings in these banks far exceeding the initial recapitalisation cost which is
something unique to the Indian banking system. Thus, the recapitalisation of banks by the
government has not been merely a holding out operation by the majority owner of the
banks. The Indian experience has shown that a strong, pragmatic and non-discriminatory
regulatory framework coupled with the market discipline effected through the listing of the
equity shares and operational autonomy provided to the banks, can have a significant positive
impact on the functioning of the public sector banks.
1.4) THE TASK AHEAD
The public sector banks face certain challenges and hence, need to work further to achieve
the desired results, particularly in regard to fuller leveraging of the available technology for
rendering better banking services to the public at large. Awareness of electronic payment
products As is well known, the financial sector has witnessed a quantum jump in the
availability of technological solutions for delivery of financial services, and the RBI too has
launched several payment system products for improving the efficiency of the payment
system. It is, however, the general perception that the awareness of these products in the
system has remained rather limited. This lack of awareness is not confined to only to the
members of public at large. It is not uncommon to find that even the branch staff, having
direct interface with the banking customers, is not aware of these products and services
offered by the bank. This has, therefore, resulted in the continued reliance of the members of
public on the traditional methods for availing of various banking services and the benefits of
technology have not fully percolated to the level of the customers. I would, therefore, like to
urge to take appropriate measures to increase the awareness of the electronic payment
products not only among the clientele of the banks but also among the banks own staff so
that the members of public can be properly guided and efficient and hassle-free customer
service is rendered to them
National Electronic Fund Transfer

As we are aware, the NEFT was launched by the RBI in November 2005 as a more secure,
nationwide retail electronic payment system to facilitate funds transfer by the bank
customers, between the networked bank branches in the country. It has, however, been
observed that the public sector banks are not the most active users of this product and the
majority of NEFT outward transactions are originated by a few new-generation private sector
banks and foreign banks. For instance, in June 2008, while these banks, as a segment,
accounted for a little over 43 per cent each of the aggregate volume of outward and inward
NEFT transactions, the share of public sector banks in total outward NEFT transactions was
rather low at a little over 12 per cent, of which half the volume was the contribution of the
State Bank of India. The RBI has been pursuing the matter with the PSBs for increasing their
participation in the NEFT system in terms of the number of NEFT-enabled branches and the
number of NEFT transactions originated by them. I would like to urge upon the bankers
present here to initiate appropriate measures to stimulate greater usage of this payment
medium and thereby, improve their share in this regard. In order to popularise the e-payments
in the country, the RBI, on its part, has waived the service charges to be levied on the
member banks, till March 31, 2009, in respect of the RTGS and NEFT transactions. The RBI
also provides, free of charge, intraday liquidity to the banks for the RTGS transactions. The
service charges to be levied by banks from their customers for RTGS & NEFT have,
however, been deregulated and left to discretion of the individual bank. It has been our
experience that while some of the banks have rationalised their service charges and a few
have made it even cost-free to the customers, there are also certain banks that have fixed
multiples slabs or unreasonably high service charges, at times linked to the amount of the
transaction, for providing these services to their customers even though the RBI provides
these services to the banks free of charge. We would therefore, like to take this opportunity to
impress upon such banks the need to have proper appreciation of the underlying policy intent
of the RBI in waiving the charges for these services, and to adopt a pragmatic approach in
determining their own service charges for providing these electronic payment products to
their customers.
ATM Networks

The National Financial Switch (NFS) network started its operations on August 27, 2004 and
is owned and operated by Institute for Development and Research in Banking Technology
(IDRBT), Hyderabad. NFS is one of the several shared ATM networks which interconnect
the banks ATM switches together and thus, enable inter-operability of the ATM cards issued
by any bank across the entire network.
While there are a few other ATM networks also functioning in the country, the NFS has
emerged to be the largest one, with a network of 28,773 ATMs of 31 banks, including 16
public sector banks.
The primary objective of any ATM network, like the NFS, is to make the ATM deployment
more economical and viable for banks by pooling their respective ATM resources. The main
advantage of an ATM network is that it obviates the need for having bank-specific multiple
ATM installations in the same geographical area, thereby reducing the entailed costs for the
banks but without compromising on the reach of the banks to their customers. From the
customers perspective, the ATM card of any bank can be used in any ATM which enables
more convenient and wider ATM access to the bank customers of varied banks in different
geographical areas. As regards the charges for use of the ATMs connected through any of the
ATM networks in the country, while the balance enquiry by the customers is free of any
charges, the cash withdrawal from such ATMs, which currently attracts a nominal charge,
would also become cost free for the customers from April 1, 2009,.
Thus, the networking of the ATMs across the country, by leveraging the technology, is
indeed a very customerfriendly development.
At end-June 2008, the number of ATMs in the country stood at 36,314 of which the number
of ATMs deployed by the PSBs, new-private-sector, old-private-sector and foreign banks was
22,525, 10,552, 2,189 and 1048 ATMs, respectively. At the system level, the banks had
planned the installation of another 10,560 ATMs during 2008-09. During the quarter ended
June 2008, the daily average number of hits on the ATMs of the PSBs aggregated 31,31,431,
with the daily average amount of transactions at Rs. 759.81 crore as against the
corresponding figure of 14,91,399 and over Rs. 385 crore for the (old and new) private sector
banks, of which the new private sector banks accounted for a loins share at 12,84, 071 hits
and around Rs. 329 crore in the value of daily transactions.
Credit Cards

There has been phenomenal increase in the number of credit cards issued by the banks in
India during the last few years and a majority of the PSBs has been in the credit card business
since long. The number of credit cards outstanding at the end of June 2008 was 27.02 million
as against 24.39 million in June 2007. Of these, the number of credit cards issued by public
sector banks was 3.8 million, of which 3.09 million cards were issued by the SBI Cards a
joint venture of GE Money and SBI. The usage of credit cards has also recorded an increase
of 10.73 per cent during the year this period, which is mainly at the Point of Sale (POS)
terminals. In June 2008, the number of transactions by credit cards at POS terminals was 20.6
million as against 17.2 million transactions in June 2007, reflecting an increase of almost 20
per cent during the year. The amount involved in these transactions recorded a growth of 25.6
per cent during the year ended June 2008 with the aggregate value of such transactions at Rs.
5261.63 crore. While the increasing usage of the credit cards is a welcome development in as
much as it reduces reliance on currency for settlement of transactions, it also entails certain
additional elements of operational risk and can be a potential source of customer complaints.
The RBI, based on the complaints received from the credit card holders, had undertaken a
study of the credit card operations of the banks. The RBI has since advised the banks in July
2008, the recommendations emerging from the study, for implementation. These
recommendations are fairly wide ranging and encompass several issues in the areas of card
issuance, card statements, interest and other chares on the cards, using the services of direct
selling / marketing agents, redressal of customers grievances, reporting of default
information of the card holder to the CIBIL, etc. We would urge the banks to put in place
necessary mechanism to ensure meticulous compliance with these instructions of the RBI so
as to minimize, if not eliminate, the risks and customer complaints in the area of credit card
operations.
Satellite banking

We might be aware, having regard to much greater reliability of a satellite-based
communication link for interconnecting the branches of the banks, particularly in the hilly
areas and difficult terrain where terrestrial communication link is difficult to provide, the RBI
had constituted a Technical Group to examine the proposal for providing satellite
connectivity to the bank branches in such areas. The objective is to enable greater penetration
of the electronic payment products in the hinterland areas also, by facilitating the integration
of the rural and remote branches with the core bankingsolution platform of the banks and
help them providing efficient banking services to their customers. Under the proposal, the
RBI would be bearing a part of the leased rentals for the satellite connectivity, provided the
banks use it for connecting their branches in the North Eastern States and in the under-banked
districts in the rest of the country. Thus, the RBI would be providing an incentive to the
banks for adopting the satellite communication technology for networking their branches in
the remote areas.
1.5) Challenges facing Banking industry in India

The banking industry in India is undergoing a major transformation due to changes in
economic conditions and continuous deregulation. These multiple changes happening one
after other has a ripple effect on a bank trying to graduate from completely regulated sellers
market to completed deregulated customers market


Deregulation:
This continuous deregulation has made the Banking market extremely competitive with
greater autonomy, operational flexibility, and decontrolled interest rate and liberalized norms
for foreign exchange. The deregulation of the industry coupled with decontrol in interest rates
has led to entry of a number of players in the banking industry. At the same time reduced
corporate credit off take thanks to sluggish economy has resulted in large number of
competitors battling for the same pie.
New rules:
As a result, the market place has been redefined with new rules of the game. Banks are
transforming to universal banking, adding new channels with lucrative pricing and freebees
to offer. Natural fall out of this has led to a series of innovative product offerings catering to
various customer segments, specifically retail credit Efficiency: This in turn has made it
necessary to look for efficiencies in the business. Banks need to access low cost funds and
simultaneously improve the efficiency. The banks are facing pricing pressure, squeeze on
spread and have to give thrust on retail assets
Diffused Customer loyalty:
This will definitely impact Customer preferences, as they are bound to react to the value
added offerings. Customers have become demanding and the loyalties are diffused. There are
multiple choices; the wallet share is reduced per bank with demand on flexibility and
customization. Given the relatively low switching costs; customer retention calls for
customized service and hassle free, flawless service delivery.
Misaligned mindset:
These changes are creating challenges, as employees are made to adapt to changing
conditions. There is resistance to change from employees and the Seller market mindset is yet
to be changed coupled with Fear of uncertainty and Control orientation. Acceptance of
technology is slowly creeping in but the utilization is not maximised.
Competency Gap:

Placing the right skill at the right place will determine success. The competency gap needs to
be addressed simultaneously otherwise there will be missed opportunities. The focus of
people will be on doing work but not providing solutions, on escalating problems rather than
solving them and on disposing customers instead of using the opportunity to cross sell.
Strategic options with banks to cope with the challenges
Leading players in the industry have embarked on a series of strategic and tactical initiatives
to sustain leadership.
The major initiatives include:
Investing in state of the art technology as the back bone of to ensure reliable service
delivery savings deposits
Making aggressive forays in the retail advances segment of home and personal loans
Implementing organization wide initiatives involving people, process and technology to
reduce the fixed costs and the cost per transaction
Focusing on fee based income to compensate for squeezed spread, (e.g. CMS, trade
services)
Innovating Products to capture customer mind share to begin with and later the wallet
share
Improving the asset quality as per Basel II norms


1.6) NON PERFORMING ASSETS (NPA)
Action for enforcement of security interest can be initiated only if the secured asset is
classified as Nonperforming asset. Non performing asset means an asset or account of
borrower, which has been classified by bank or financial institution as sub standard ,
doubtful or loss asset, in accordance with the direction or guidelines relating to assets
classification issued by RBI . An amount due under any credit facility is treated as past due
when it is not been paid within 30 days from the due date. Due to the improvement in the
payment and settlement system, recovery climate, up gradation of technology in the banking
system etc, it was decided to dispense with past due concept, with effect from March 31,
2001. Accordingly as from that date, a Non performing asset shell be an advance where
i. Interest and/or instalment of principal remain overdue for a period of more than 180 days in
respect of a term loan,
ii. The account remains out of order for a period of more than 180 days, in respect of an
overdraft/cash credit (OD/CC)
iii. The bill remains overdue for a period of more than 180 days in case of bill purchased or
discounted.
iv. Interest and/or principal remains overdue for two harvest season but for a period not
exceeding two half years in case of an advance granted for agricultural purpose, and
v. Any amount to be received remains overdue for a period of more than 180 days in respect
of other accounts
With a view to moving towards international best practices and to ensure greater
transparency, it has been decided to adopt 90 days overdue norms for identification of NPA
s, from the year ending March 31, 2004, a non performing asset shell be a loan or an advance
where;
i. Interest and/or instalment of principal remain overdue for a period of more than 90 days
in respect of a term loan,
ii. The account remains out of order for a period of more than 90 days ,in respect of an

overdraft/cash credit (OD/CC)
iii. The bill remains overdue for a period of more than 90 days in case of bill purchased or
discounted.
iv. Interest and/or principal remains overdue for two harvest season but for a period not
exceeding two half years in case of an advance granted for agricultural purpose, and
v. Any amount to be received remains overdue for a period of more than 90 days in respect of
other accounts
Out of order
An account should be treated as out of order if the outstanding balance remains continuously
in excess of sanctioned limit /drawing power. in case where the out standing balance in the
principal operating account is less than the sanctioned amount /drawing power, but there are
no credits continuously for six months as on the date of balance sheet or credit are not enough
to cover the interest debited during the same period ,these account should be treated as out of
order.
Overdue
Any amount due to the bank under any credit facility is overdue if it is not paid on due date
fixed by the bank.
1.7) FACTORS FOR RISE IN NPAs
The banking sector has been facing the serious problems of the rising NPAs. But the problem
of NPAs is more in public sector banks when compared to private sector banks and foreign
banks. A strong banking sector is important for a flourishing economy. The failure of the
banking sector may have an adverse impact on other sectors. The Indian banking system,
which was operating in a closed economy, now faces the challenges of an open economy. On
one hand a protected environment ensured that banks never needed to develop sophisticated
treasury operations and Asset Liability Management skills. On the other hand a combination
of directed lending and social banking relegated profitability and competitiveness to the
background. The net result was unsustainable NPAs and consequently a higher effective cost
of banking services.


The problem India Faces is not lack of strict prudential norms but
i. The legal impediments and time consuming nature of asset disposal proposal.
ii. Postponement of problem in order to show higher earnings.
iii. Manipulation of debtors using political influence.
Macro Perspective behind NPAs
A lot of practical problems have been found in Indian banks, especially in public sector
banks. For Example, the government of India had given a massive wavier of Rs. 15,000 Crs.
under the Prime Minister ship of Mr. V.P. Singh, for rural debt during 1989-90. This was not
a unique incident in India and left a negative impression on the payer of the loan. Poverty
elevation programs like IRDP, RREP, SUME, SEPUP, JRY, PMRY etc., failed on various
grounds in meeting their objectives. The huge amounts of loan granted under these schemes
were totally unrecoverable by banks due to political manipulation, misuse of funds and non-
reliability of target audience of these sections. Loans given by banks are their assets and as
the repayments of several of the loans were poor, the qualities of these assets were steadily
deteriorating. Credit allocation became 'Lon Melas', loan proposal evaluations were slack and
as a result repayments were very poor.
There are several reasons for an account becoming NPA.
* Internal factors
* External factors
EXTERNAL FACTORS
Ineffective recovery tribunal
The Govt. has set of numbers of recovery tribunals, which works for recovery of loans and
advances. Due to their negligence and ineffectiveness in their work the bank suffers the
consequence of non-recover, their by reducing their profitability and liquidity.


Willful Defaults
There are borrowers who are able to payback loans but are intentionally withdrawing it.
These groups of people should be identified and proper measures should be taken in order to
get back the money extended to them as advances and loans.
Natural calamities
This is the measure factor, which is creating alarming rise in NPAs of the PSBs. Every now
and then India is hit by major natural calamities thus making the borrowers unable to pay
back there loans. Thus the bank has to make large amount of provisions in order to
compensate those loans, hence end up the fiscal with a reduced profit.
Mainly our farmers depends on rain fall for cropping. Due to irregularities of rain fall the
framers are not to achieve the production level thus they are not repaying the loans.
Industrial sickness
Improper project handling , ineffective management , lack of adequate resources , lack of
advance technology , day to day changing govt. Policies give birth to industrial sickness.
Hence the banks that finance those industries ultimately end up with a low recovery of their
loans reducing their profit and liquidity.
Lack of demand
Entrepreneurs in India could not foresee their product demand and starts production which
ultimately piles up their product thus making them unable to pay back the money they borrow
to operate these activities. The banks recover the amount by selling of their assets, which
covers a minimum label. Thus the banks record the non recovered part as NPAs and has to
make provision for it.
Change on Govt. policies

With every new govt. banking sector gets new policies for its operation. Thus it has to cope
with the changing principles and policies for the regulation of the rising of NPAs. The fallout
of handloom sector is continuing as most of the weavers Co-operative societies have become
defunct largely due to withdrawal of state patronage. The rehabilitation plan worked out by
the Central govt to revive the handloom sector has not yet been implemented. So the over
dues due to the handloom sectors are becoming NPAs.
Apart from these factors there may be others external factors which can cause of NPAs,
these factors are:
1. Sluggish legal system - Long legal tangles Changes that had taken place in labour laws
Lack of sincere effort.
2. Scarcity of raw material, power and other resources.
3. Industrial recession.
4. Shortage of raw material, raw material\input price escalation, power shortage, industrial
recession, excess capacity, natural calamities like floods, accidents.
5. Failures, non payment\ over dues in other countries, recession in other countries,
externalization problems, adverse exchange rates etc.
6. Government policies like excise duty changes, Import duty changes etc.,
INTERNAL FACTORS
Defective Lending process
There are three cardinal principles of bank lending that have been followed by the
commercial banks since long.
i. Principles of safety
ii. Principle of liquidity
iii. Principles of profitability
i. Principles of safety
By safety it means that the borrower is in a position to repay the loan both principal and
interest. The repayment of loan depends upon the borrowers:
a. Capacity to pay
b. Willingness to pay
Capacity to pay depends upon: 1. Tangible assets 2. Success in business

Willingness to pay depends on: 1. Character 2. Honest 3. Reputation of borrower
The banker should, there fore take utmost care in ensuring that the enterprise or business for
which a loan is sought is a sound one and the borrower is capable of carrying it out
successfully .he should be a person of integrity and good character.
Inappropriate technology
Due to inappropriate technology and management information system, market driven
decisions on real time basis can not be taken. Proper MIS and financial accounting system is
not implemented in the banks, which leads to poor credit collection, thus NPA. All the
branches of the bank should be computerized.
Improper SWOT Analysis
The improper strength, weakness, opportunity and threat analysis is another reason for rise in
NPAs. While providing unsecured advances the banks depend more on the honesty, integrity,
and financial soundness and credit worthiness of the borrower.
1. Banks should consider the borrowers own capital investment.
2. It should collect credit information of the borrowers from
a. From bankers
b. Enquiry from market/segment of trade, industry, business.
c. From external credit rating agencies. Analyse the balance sheet
True picture of business will be revealed on analysis of profit/loss a/c and balance sheet.
3. Purpose of the loan
When bankers give loan, he should analyse the purpose of the loan. To ensure safety and
liquidity, banks should grant loan for productive purpose only. Bank should analyse the
profitability, viability, long term acceptability of the project while financing.
Poor credit appraisal system

Poor credit appraisal is another factor for the rise in NPAs. Due to poor credit appraisal the
bank gives advances to those who are not able to repay it back. They should use good credit
appraisal to decrease the NPAs.
Managerial deficiencies
The banker should always select the borrower very carefully and should take tangible assets
as security to safe guard its interests. When accepting securities banks should consider the
1. Marketability
2. Acceptability
3. Safety
4. Transferability.
The banker should follow the principle of diversification of risk based on the famous maxim
do not keep all the eggs in one basket; it means that the banker should not grant
advances to a few big farms only or to concentrate them in few industries or in a few cities. If
a new big customer meets misfortune or certain traders or industries affected adversely, the
overall position of the bank will not be affected.
Like OSCB suffered loss due to the OTM Cuttack, and Orissa hand loom industries. The
biggest defaulters of OSCB are the OTM (117.77lakhs), and the handloom sector Orissa
hand loom WCS ltd (2439.60lakhs).
Absence of regular industrial visit
The irregularities in spot visit also increases the NPAs. Absence of regularly visit of bank
officials to the customer point decreases the collection of interest and principals on the loan.
The NPAs due to wilful defaulters can be collected by regular visits.
Re loaning process
Non remittance of recoveries to higher financing agencies and re loaning of the same have
already affected the smooth operation of the credit cycle. Due to re loaning to the defaulters
and CCBs and PACs, the NPAs of OSCB is increasing day by day.
Apart from these the other internal factors are:
1. Funds borrowed for a particular purpose but not use for the said purpose.

2. Project not completed in time.
3. Poor recovery of receivables.
4. Excess capacities created on non-economic costs.
5. In-ability of the corporate to raise capital through the issue of equity or other debt
instrument from capital markets.
6. Business failures.
7. Diversion of funds for expansion\modernization\setting up new projects\ helping or
promoting sister concerns.
8. Willful defaults, siphoning of funds, fraud, disputes, management disputes,
misappropriation etc.,
9. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and followups,
delay in settlement of payments\ subsidiaries by government bodies etc.,
1.7) PROBLEMS DUE TO NPA
1. Owners do not receive a market return on there capital .in the worst case, if the banks fails,
owners loose their assets. In modern times this may affect a broad pool of shareholders.
2. Depositors do not receive a market return on saving. In the worst case if the bank fails,
depositors loose their assets or uninsured balance.
3. Banks redistribute losses to other borrowers by charging higher interest rates, lower
deposit rates and higher lending rates repress saving and financial market, which hamper
economic growth.
4. Non performing loans epitomize bad investment. They misallocate credit from good
projects, which do not receive funding, to failed projects. Bad investment ends up in
misallocation of capital, and by extension, labour and natural resources.
5. Non performing asset may spill over the banking system and contract the money stock,
which may lead to economic contraction. This spill over effect can channelize through
liquidity or bank insolvency:

a) when many borrowers fail to pay interest, banks may experience liquidity shortage. This
can jam payment across the country,
b) illiquidity constraints bank in paying depositors .
c) undercapitalised banks exceeds the banks capital base.
1.8) What caused such high NPAs in the system until 1995?
Some key reasons for huge NPAs until mid-1990s are as follows:
Absence of competition:
The entire banking sector was state-owned; there was complete absence of any kind of
competition from the private sector.
Lack of focus and control:
The government-controlled operations of banks resulted in favoritisms in terms of lending,
besides lack of focus on quality of lending. Managements of banks lacked any control on
operations of their banks, while directors largely were influenced by the will of power-
circles.
Collateral-based lending and a dormant legal recourse system:
Collateral was considered king. Under the name of collateral, large sums of loans were
disbursed, and in the absence of an active legal recovery system, loan repayment and quality
considerations took a back seat.
Corruption and bureaucracy:
Political interference and lack of supervision increased corruption and redtapism in the
banking system. This resulted in complete dilution of credit quality and control procedures.
Inadequacy of capital and tools relating to asset quality monitoring:
Banks suffered from shortage of capital funds to pursue any meaningful investments in
quality control, loan monitoring, etc. This inadequacy of funds, together with the absence of
independent management, led to low focus on asset quality tracking and taking corrective
actions.

The situation changed after 1993, when the Reserve Bank of India (RBI) with the
government's support, came up with several decisions on managing Indian banks that had a
salutary impact, and the future never looked so much in control henceforth. There was a
significant decline in the non-performing assets (NPAs) of SCBs in 2003-04, despite
adoption of 90 day delinquency norm from March 31, 2004. The gross NPAs of SCBs
declined from 4.0 per cent of total assets in 2002-03 to 3.3 per cent in 2003-04. The
corresponding decline in net NPAs was from 1.9 per cent to 1.2 per cent. Both gross NPAs
and net NPAs declined in absolute terms. While the gross NPAs declined from Rs. 68,717
crore in 2002-03 to Rs. 64,787 crore in 2003-04, net NPAs declined from Rs. 32,670 crore to
Rs. 24,617 crore in the same period. There was also a significant decline in the proportion of
net NPAs to net advances from 4.4 per cent in 2002-03 to 2.9 per cent in 2003-04. The
significant decline in the net NPAs by 24.7 per cent in 2003-04 as compared to 8.1 per cent in
2002- 03 was mainly on account of higher provisions (up to 40.0 per cent) for NPAs made by
SCBs. The decline in NPAs in 2003-04 was witnessed across all bank groups.
The decline in net NPAs as a proportion of total assets was quite significant in the case of
new private sector banks, followed by PSBs. The ratio of net NPAs to net advances of SCBs
declined from 4.4 per cent in 2002-03 to 2.9 per cent in 2003-04. Among the bank groups,
old private sector banks had the highest ratio of net NPAs to net advances at 3.8 per cent
followed by PSBs (3.0 per cent) new private sector banks (2.4 per cent) and foreign banks
(1.5 per cent) An analysis of NPAs by sectors reveals that in 2003-04, advances to non-
priority sectors accounted for bulk of the outstanding NPAs in the case of PSBs (51.24 per
cent of total) and for private sector banks (75.30 per cent of total). While the share of NPAs
in agriculture sector and SSIs of PSBs declined in 2003-04, the share of other priority sectors
increased. The share of loans to other priority sectors in priority sector lending also increased.
Measures taken to reduce NPAs include reschedulement, restructuring at the bank level,
corporate debt restructuring, and recovery through Lok Adalats, Civil Courts, and debt
recovery tribunals and compromise settlements.

The recovery management received a major fillip with the enactment of the Securitisation
and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)
Act, 2002 enabling banks to realise their dues without intervention of courts and tribunals.
The Supreme Court in its judgment dated April 8, 2004, while upholding the constitutional
validity of the Act, struck down section 17 (2) of the Act as unconstitutional and contrary to
Article 14 of the Constitution of India. The Government amended the relevant provisions of
the Act to address the concerns expressed by the Supreme Court regarding a fair deal to
borrowers through an ordinance dated November 11, 2004. It is expected that the momentum
in the recovery of NPAs will be resumed with
the amendments to the Act. The revised guidelines for compromise settlement of chronic
NPAs of PSBs were issued in January 2003 and were extended from time to time till July 31,
2004. The cases filed by SCBs in Lok Adalats for recovery of NPAs stood at 5.20 lakh
involving an amount of Rs. 2,674 crore (prov.). The recoveries effected in 1.69 lakh cases
amounted to Rs. 352 crore (prov.) as on September 30, 2004.
The number of cases filed in debt recovery tribunals stood at 64, 941 as on June 30, 2004,
involving an amount of Rs. 91,901 crore.
Out of these, 29, 525 cases involving an amount of Rs. 27,869 crore have been adjudicated.
The amount recovered was to Rs. 8,593 crore. Under the scheme of corporate debt
restructuring introduced in 2001, the number of cases and value of assets restructured stood at
121 and Rs. 69,575 crore, respectively, as on December 31, 2004.
Iron and steel, refinery, fertilisers and telecommunication sectors were the major
beneficiaries of the scheme. These sectors accounted for more than two-third of the values of
assets restructured
Capital adequacy ratio
The concept of minimum capital to risk weighted assets ratio (CRAR) has been developed to
ensure that banks can absorb a reasonable level of losses. Application of minimum CRAR
protects the interest of depositors and promotes stability and efficiency of the financial
system. At the end of March 31, 2004, CRAR of PSBs stood at 13.2 per cent, an
improvement of 0.6 percentage point from the previous year. There was also an improvement
in the CRAR of old private sector banks from 12.8 per cent in 2002- 03 to 13.7 per cent in
2003-04. The CRAR of new private sector banks and foreign banks registered a decline in
2003-04. For the SCBs as a whole the CRAR improved from 12.7 per cent in 2002-03 to 12.9
per cent in 2003-04. All the bank groups had CRAR above the minimum 9 per cent stipulated
by the RBI. During the current year, there was further improvement in the CRAR of SCBs.
The ratio in the first half of 2004-05 improved to 13.4 per cent as compared to 12.9 per cent
at the end of 2003-04. Among the bank groups, a substantial improvement was witnessed in
the case of new private sector banks from 10.2 per cent as at the end of 2003-04 to 13.5
percent in the first half of 2004-05.

While PSBs and old private banks maintained the CRAR at almost the same level as in
the previous year, the CRAR of foreign banks declined to 14.0 per cent in the first half of
2004-05 as compared to 15.0 per cent as at the end of 2003-04.

The above picture is self-explanatory. Over the period of time, Indian commercial banks have
shown tremendous improvement in terms of quality of credit. NPAs, both at gross and net
levels, as a percentage of advances, have fallen consistently. The gross NPA/Advances ratio
has fallen from 16% in FY97 to less than 2.5% in FY08. Banks displayed great control over
credit quality, as even in times of falling IIP and GDP growth, they continued to show fewer
NPAs. This is a very impressive indicator that highlights the fact that Indian banking has
shown substantial improvement in terms of asset quality management even in adverse macro-
economic conditions. FY99, FY01 and FY02 saw considerable fall in industrial production
from the then existing levels.
However, this did not lead to any increase in bank NPAs. On the contrary, banks improved
NPA ratios considerably through the exercise of strong asset quality monitoring programmes.
The current environment is again indicating a decline in GDP, and IIP growth rates as
slowdown hits demand and consumption across all major sectors.
However, we strongly believe that managements of top Indian banks have put 'NPA
Management and Control' as one of their top priorities, and that even though there would be a
jump in NPAs as a proportion of total assets, the banking sector has the ability to withstand
this jump and still emerge as a strong performer in these extremely difficult times.

1.9) PROBLEMS DUE TO NPA
1. Owners do not receive a market return on there capital .in the worst case, if the banks fails,
owners loose their assets. In modern times this may affect a broad pool of shareholders.
2. Depositors do not receive a market return on saving. In the worst case if the bank fails,
depositors loose their assets or uninsured balance.
3. Banks redistribute losses to other borrowers by charging higher interest rates, lower
deposit rates and higher lending rates repress saving and financial market, which hamper
economic growth.
4. Non performing loans epitomize bad investment. They misallocate credit from good
projects, which do not receive funding, to failed projects. Bad investment ends up in
misallocation of capital, and by extension, labour and natural resources.
5. Non performing asset may spill over the banking system and contract the money stock,
which may lead to economic contraction. This spill over effect can channelize through
liquidity or bank insolvency:
a) when many borrowers fail to pay interest, banks may experience liquidity shortage. This
can jam payment across the country,
b) illiquidity constraints bank in paying depositors .
c) undercapitalised banks exceeds the banks capital base.
1.10) What caused such high NPAs in the system until 1995?
Some key reasons for huge NPAs until mid-1990s are as follows:
Absence of competition:
The entire banking sector was state-owned; there was complete absence of any kind of
competition from the private sector.
Lack of focus and control:

The government-controlled operations of banks resulted in favoritisms in terms of lending,
besides lack of focus on quality of lending. Managements of banks lacked any control on
operations of their banks, while directors largely were influenced by the will of power-
circles.
Collateral-based lending and a dormant legal recourse system:
Collateral was considered king. Under the name of collateral, large sums of loans were
disbursed, and in the absence of an active legal recovery system, loan repayment and quality
considerations took a back seat.
Corruption and bureaucracy:
Political interference and lack of supervision increased corruption and redtapism in the
banking system. This resulted in complete dilution of credit quality and control procedures.
Inadequacy of capital and tools relating to asset quality monitoring:
Banks suffered from shortage of capital funds to pursue any meaningful investments in
quality control, loan monitoring, etc. This inadequacy of funds, together with the absence of
independent management, led to low focus on asset quality tracking and taking corrective
actions.
The situation changed after 1993, when the Reserve Bank of India (RBI) with the
government's support, came up with several decisions on managing Indian banks that had a
salutary impact, and the future never looked so much in control henceforth. There was a
significant decline in the non-performing assets (NPAs) of SCBs in 2003-04, despite
adoption of 90 day delinquency norm from March 31, 2004. The gross NPAs of SCBs
declined from 4.0 per cent of total assets in 2002-03 to 3.3 per cent in 2003-04. The
corresponding decline in net NPAs was from 1.9 per cent to 1.2 per cent. Both gross NPAs
and net NPAs declined in absolute terms. While the gross NPAs declined from Rs. 68,717
crore in 2002-03 to Rs. 64,787 crore in 2003-04, net NPAs declined from Rs. 32,670 crore to
Rs. 24,617 crore in the same period. There was also a significant decline in the proportion of
net NPAs to net advances from 4.4 per cent in 2002-03 to 2.9 per cent in 2003-04. The
significant decline in the net NPAs by 24.7 per cent in 2003-04 as compared to 8.1 per cent in
2002- 03 was mainly on account of higher provisions (up to 40.0 per cent) for NPAs made by
SCBs. The decline in NPAs in 2003-04 was witnessed across all bank groups.

The decline in net NPAs as a proportion of total assets was quite significant in the case of
new private sector banks, followed by PSBs. The ratio of net NPAs to net advances of SCBs
declined from 4.4 per cent in 2002-03 to 2.9 per cent in 2003-04. Among the bank groups,
old private sector banks had the highest ratio of net NPAs to net advances at 3.8 per cent
followed by PSBs (3.0 per cent) new private sector banks (2.4 per cent) and foreign banks
(1.5 per cent) An analysis of NPAs by sectors reveals that in 2003-04, advances to non-
priority sectors accounted for bulk of the outstanding NPAs in the case of PSBs (51.24 per
cent of total) and for private sector banks (75.30 per cent of total). While the share of NPAs
in agriculture sector and SSIs of PSBs declined in 2003-04, the share of other priority sectors
increased. The share of loans to other priority sectors in priority sector lending also increased.
Measures taken to reduce NPAs include reschedulement, restructuring at the bank level,
corporate debt restructuring, and recovery through Lok Adalats, Civil Courts, and debt
recovery tribunals and compromise settlements.
The recovery management received a major fillip with the enactment of the Securitisation
and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI)
Act, 2002 enabling banks to realise their dues without intervention of courts and tribunals.
The Supreme Court in its judgment dated April 8, 2004, while upholding the constitutional
validity of the Act, struck down section 17 (2) of the Act as unconstitutional and contrary to
Article 14 of the Constitution of India. The Government amended the relevant provisions of
the Act to address the concerns expressed by the Supreme Court regarding a fair deal to
borrowers through an ordinance dated November 11, 2004. It is expected that the momentum
in the recovery of NPAs will be resumed with
the amendments to the Act. The revised guidelines for compromise settlement of chronic
NPAs of PSBs were issued in January 2003 and were extended from time to time till July 31,
2004. The cases filed by SCBs in Lok Adalats for recovery of NPAs stood at 5.20 lakh
involving an amount of Rs. 2,674 crore (prov.). The recoveries effected in 1.69 lakh cases
amounted to Rs. 352 crore (prov.) as on September 30, 2004.
The number of cases filed in debt recovery tribunals stood at 64, 941 as on June 30, 2004,
involving an amount of Rs. 91,901 crore.

Out of these, 29, 525 cases involving an amount of Rs. 27,869 crore have been adjudicated.
The amount recovered was to Rs. 8,593 crore. Under the scheme of corporate debt
restructuring introduced in 2001, the number of cases and value of assets restructured stood at
121 and Rs. 69,575 crore, respectively, as on December 31, 2004.
Iron and steel, refinery, fertilisers and telecommunication sectors were the major
beneficiaries of the scheme. These sectors accounted for more than two-third of the values of
assets restructured
Capital adequacy ratio
The concept of minimum capital to risk weighted assets ratio (CRAR) has been developed to
ensure that banks can absorb a reasonable level of losses. Application of minimum CRAR
protects the interest of depositors and promotes stability and efficiency of the financial
system. At the end of March 31, 2004, CRAR of PSBs stood at 13.2 per cent, an
improvement of 0.6 percentage point from the previous year. There was also an improvement
in the CRAR of old private sector banks from 12.8 per cent in 2002- 03 to 13.7 per cent in
2003-04. The CRAR of new private sector banks and foreign banks registered a decline in
2003-04. For the SCBs as a whole the CRAR improved from 12.7 per cent in 2002-03 to 12.9
per cent in 2003-04. All the bank groups had CRAR above the minimum 9 per cent stipulated
by the RBI. During the current year, there was further improvement in the CRAR of SCBs.
The ratio in the first half of 2004-05 improved to 13.4 per cent as compared to 12.9 per cent
at the end of 2003-04. Among the bank groups, a substantial improvement was witnessed in
the case of new private sector banks from 10.2 per cent as at the end of 2003-04 to 13.5
percent in the first half of 2004-05.
While PSBs and old private banks maintained the CRAR at almost the same level as in
the previous year, the CRAR of foreign banks declined to 14.0 per cent in the first half of
2004-05 as compared to 15.0 per cent as at the end of 2003-04.

The above picture is self-explanatory. Over the period of time, Indian commercial banks have
shown tremendous improvement in terms of quality of credit. NPAs, both at gross and net
levels, as a percentage of advances, have fallen consistently. The gross NPA/Advances ratio
has fallen from 16% in FY97 to less than 2.5% in FY08. Banks displayed great control over
credit quality, as even in times of falling IIP and GDP growth, they continued to show fewer
NPAs. This is a very impressive indicator that highlights the fact that Indian banking has
shown substantial improvement in terms of asset quality management even in adverse macro-
economic conditions. FY99, FY01 and FY02 saw considerable fall in industrial production
from the then existing levels.
However, this did not lead to any increase in bank NPAs. On the contrary, banks improved
NPA ratios considerably through the exercise of strong asset quality monitoring programmes.
The current environment is again indicating a decline in GDP, and IIP growth rates as
slowdown hits demand and consumption across all major sectors.
However, we strongly believe that managements of top Indian banks have put 'NPA
Management and Control' as one of their top priorities, and that even though there would be a
jump in NPAs as a proportion of total assets, the banking sector has the ability to withstand
this jump and still emerge as a strong performer in these extremely difficult times.
1.11) What changed the scenario of NPAs after 1995?
Some of the key factors that contributed to the fall in NPAs in the Indian banking
Introduction of competition:
The RBI opened up gates for the private sector participation in the Indian banking industry.
HDFC, the principal mortgage lender, got the first approval to start a private bank in the
reform-driven era. HDFC Bank was given permission to carry on commercial banking
operations. Many new private banks and foreign banks were allowed later, which brought in
the much-required competition in the Indian banking industry.
Guidelines on NPAs, income recognition, capital adequacy:

One of the key reasons for such a drastic fall in system NPAs was the introduction of asset
and capital quality guidelines. These norms, introduced on the basis of the Narasimhan
Committee report in 1993, had a revolutionary impact on the way banks managed and
controlled their asset book.
Separation of control:
Bank managements were given a free hand to run their businesses as the Ministry of Finance
and the RBI moved away from controlling positions to supervising and regulating positions.
This enabled boards of Indian banks to take uninfluenced calls as to lending and asset control.
Improvement of the legal recourse mechanism:
This is another significant step. Through Debt Recovery Tribunal (DRT), Lok Adalat
mechanism for small loans, and One-Time Settlement (OTS) mechanism for stressed loans in
1999, the central bank ensured that there is a quick clean-up of sticky assets, so as to enable
banks to start functioning with a clean slate. The legal recourse for amounts lent has been an
important contributor to asset quality improvement.
Capital infusion:
Public banks were allowed to bring down the government holding to 51%, thereby enabling
flow of fresh money for much-needed banks and also roping in investment interest from
market participants. Board of directors now became more independent, and a mixed lot of
individuals brought in experience from various segments of the financial world.
Establishment of CIBIL:
Credit Information Bureau of India Ltd was established in 2000. This institution started to
maintain a database of borrowers and their credit history. This served as a very effective tool
for loan sanctioning and asset quality maintenance.
Banks use the database to ensure credit does not fall in the hands of a borrower, with a bad
credit record.
Asset Reconstruction Company:
ARCs were permitted to operate from 2002; these institutions helped the removal of bank's
focus on bad assets by acquiring their bad loans, thereby strengthening their balance sheets.
Corporate Debt Restructuring, SICA:

The CDR mechanism, sick industries revival enactments enabled addressing issues of
troubled borrowers through effective handholding and bank support. This prevented further
slippage of asset quality.
Exposure limits (sector-wise and borrower-wise):
The RBI put in place strict exposure limits for banks with respect to sensitive sectors like real
estate and capital markets. In addition, limits on amounts a bank can lend to a specific
borrower, or a borrower group helped in non-concentration of funds as loans in a few hands,
thereby diversifying the risk of default.
Risk management tools:
The RBI ensured that banks have effective risk measurement, management and control
systems in place, so as to avoid credit shocks.
Asset liability management (ALM), value at risk (VAR), control on off-balance sheet
exposures, credit risk weightages, etc. are few concepts that enabled banks to effectively
control NPAs.
In this context of a highly improved, dynamic and competitive domestic banking
environment, we expect that Indian banks will exercise adequate caution in terms of the
quality of their loan-books. In addition, some of the steps (underlined) can be effectively used
again by RBI and the government, if the condition of NPAs worsens.
Have Indian banks achieved the best asset quality levels?
In terms of global comparisons (table below), the performance of Indian banks over the years
has surely been exemplary, and with regard to further scope for improvement, there are many
countries where GNPA/advances ratio is much below levels at which Indian banks are
currently positioned.
This shows there is further scope for quality improvements for banks in India.


Efficiency and return parameters - Room for betterment?

As can be observed from the above chart, Indian banks have kept their operating expenses
under check. From around 3% levels during 1996 and 1997, operating expenses/assets ratio
has come down to 1.8% levels by the end of FY2008. Though this is a good indicator
reflecting the efficiency of Indian banks, it is still higher as compared with banks in other
countries such as China, Malaysia, Korea and Thailand where the ratio is below 1.5%. In
addition, one reason that might have contributed positively to Indian banks is the fact that
over the past 3-4 years there has been a rapid increase in bank loans, and hence, the balance
sheet size of banks. The higher base (as advances and total assets) might have helped in the
ratio falling to low levels. Return on assets ratio comparison table above shows that most
other banks earn better returns as compared with their Indian peers. Considering the fact that
the loan quality is improving and expenses are under control, Indian banks identified the need
to improve the profitability. Focus on fee income that is less sensitive to interest rate
fluctuations (unlike NIMs and treasury income) has been defined as one key area besides
expenses control that Indian banks would strive for in the future to improve the return
generated over assets. Providing various value-added financial services under one umbrella
has also been aimed at to improve the bottom-line.

From the above paragraphs, it can be inferred that though Indian banking has shown
tremendous improvement over the years in terms of asset quality and efficiency, the
comparison with global peers in terms of these aspects and return on assets shows that there
is still ample scope for improvement.
Indian Banking - Internal dynamics - Changed circumstances
In terms of the domestic scenario, as shown in the chart below, bank credit in FY08 has been\
growing at a slower pace than that observed over the past 4 years. The central bank tried to
ensure that the economy does not get overheated by raising the 'repo rate' regularly. Rates
were slashed from the period starting October 2008 to support liquidity in the domestic
market that had become extremely scarce due to global credit crisis. The average 3-year
credit growth steadily rose to 29% during 2005-08 from 14% levels observed between 1996
and 1999. Though the RBI's target credit growth is in the vicinity of 20% for FY09, yearly
credit growth as of November 2008 remained at 26%, above the level targeted by the central
bank.


In addition to the objective of slowing or moderating the pace of credit growth, the RBI had
to control the sudden spike in domestic inflation that rose to levels not seen at least for more
than a decade. Inflation shot up to above 12% during July 2008 due to a hike in fuel prices
and increase in commodity and food prices. However, inflation started to cool off from mid-
September 2008, as global crude and commodity prices crashed due to recession worries.
Prices of primary articles, representing food and agriculture products, still remain firm, but
the overall inflation has fallen to 9% levels in November 2008. The data indicates how
inflation, indicated by the wholesale price index (WPI), shot up from around 4% levels in
FY97 to 12% by 1HFY09. The impact of increasing inflation, rising interest rates (repo rate)
and slowing credit growth on Indian banks was seen in increasing cost of funds, increasing
pressure on the asset quality and squeezing of margins. The movement of BSE Bankex, the
share-price index of banks, reflects the impact of all the above factors. An inverse correlation
between Inflation and the Bankex movement is clearly observed until September 2008, when
global credit crisis started to pull down prices of all bank stocks even when inflation cooled
off significantly. Today, the situation is vastly different! Inflation has cooled off to 6% and
high credit growth does not pose a threat to RBI anytime soon
In short, the following aspects are key arguments for our positive view on Indian
banks in the current environment:
NPAs will rise to 5% at gross level as a percentage of advances, almost double from current
levels. However, considering the regulatory and systemic changes that have happened after
mid-1990s, Indian banks have become extremely conscious and strong in terms of managing
and maintaining credit quality Credit growth has slowed as compared with previous years,
but even assuming a slow
GDP growth due to global recession, Indian banks have adequate demand from the system to
cater to, and this will ensure decent growth in business. The bank credit is evenly diversified
to all major sectors of the economy without undue reliance on any single segment or industry.
In terms of credit quality, the return on assets, operating expenses and the scope for private
sector credit growth, Indian banks have shown tremendous improvement over a period of
time.

However, considering global examples, there is enough room to improve further in each
of the above parameters. Indian banks withstood the fall in economic growth observed during
the periods of Asian economic crisis (FY98-99), and also the global slump seen
during FY01-02. Even when global GDPs fell and domestic industrial production declined,
NPAs were effectively controlled. The market share of advances and deposits is spread
between many banks across public and private sector indicating no concentration of NPA
risks in one single bank.
GROSS NPA, GROSS ADVANCES

Why it feels that markets expectation of a huge rise in NPAs from current levels may
be unreasonable?

Bad loans are not concentrated in any single segment. The chart below shows the distribution
of gross NPAs of Indian banks as at the end of FY08. Non-concentration of low quality loans
in any single borrowing segment will reduce the overall impact of the economic slowdown,
as segments like agriculture, among some others, would not add to the pain on account of
their non-dependence on the current economic slowdown.

The corporate sector of India has improved its financial soundness over the past few
years (industry segment borrows 40% of total loans). The debt-equity ratio of Indian
companies has fallen to less than 0.5 levels from highs of 1.2 times observed during the mid-
1990s. Also, the profitability of companies has substantially improved as is evident from the
chart below, which shows the growth in shareholders equity (capital + reserves) of BSE-500
companies. These factors provide cushion to lenders on two fronts: one, borrowers quality is
good (improved), and the other, there are sufficient reserves with the borrower to tide over
the slowdown pain for a while.
Speedy legal/quasi-legal recourse in the form of Debt Recovery Tribunals, Lok Adalats,
Corporate Debt Restructuring (CDR) mechanism and One-time Settlements have yielded
positive results both in terms of time taken to recover the amount lent and also the success
rate. Under the CDR mechanism, cases involving INR830bn have been resolved that
comprises 165 corporate accounts. Only 31 cases referred to the CDR failed.

Securitisation of sticky assets that was made easier for banks by the promulgation of
SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002) also provides a great impetus to the recovery procedures adopted
by banks. Balance sheets of banks would be much cleaner when they dispose of bad loans to
a securitisation company. Loans totaling INR9.8bn and INR17.4bn have been sold in FY07
and FY08, respectively, to ARCIL, the biggest asset securitisation company in India. The
entry of ARCIL into the retail loan segment, a segment that is currently experiencing high
default rates, will benefit Indian banks.
CIBIL (Credit Information Bureau of India Ltd) was established in 2000, with SBI and
HDFC holding 40% stakes each, and Dun & Bradstreet and TransUnion holding 10% each of
the balance. The credit information bureau is a repository of information, which contains the
credit history of commercial and consumer borrowers. Member banks/institutions exchange
customer credit appraisal-related data, and thus accounts with a poor credit record are
identified for proper action. Currently, most banks are members of CIBIL.


Besides the above factors, we believe that the RBI will be proactive in modifying the NPA-
recognition norms, provisioning norms that will enable a wider window for banks to deal
with the NPA issue. Even though these measures might cover bad quality loans for a certain
period of time, they support the idea to provide recovery time for borrowers to achieve
financial health helping banks, at the same time, to provide less to such accounts in the form
of NPAs.
All these reasons, together with certain other parameters that we have explained in the
following paragraphs, make us believe that NPAs will not zoom up to such levels that could
pose a threat to the solvency of any banks, or even profitability for that matter! NPAs will
rise, but they will not go up to unreasonable levels.
Given below is a chart depicting future GNPA levels that we have considered for banks
covered in this report. NPAs will show the maximum impact in FY10, though problems in
the real economy began to appear from the beginning of 2HFY09. This is due to the fact that
NPA-recognition norms prescribe a 90-day period before assigning a mandatory 'non-
performing' tag to the asset head


1.12 Literature Survey
Non performing Assets in banking Industry has became a subject of intense importance
and discussion . It has assumed greater significance in the world of banking and banks. It has
become a barometer of the health of banks and discussions on any bank is incomplete without
the mention of NPA, NPA has now become heart of the banking Industry, which in turn, is
the heart of finance and economy of a nation
Research articles
NPA VARIATION ACROSS INDIAN COMMERCIAL BANKS
By:-
Indira Rajaraman
Sumon Bhaumik
Namit Bhatia
The Indian Commercial Banking Sector is characterized by both a high average non-
performing share in total bank advances and a high dispersion between banks. This paper
presents the findings of a formal attempt to explain inter bank variations in NPAs for the year
1996-97. The specification tests for the impact of region of operation on domestically-owned
banks, as measured by percentage branches in each of a set of state cluster. One cluster of
three eastern and seven northern-eastern states carries a robust and statistically significant
positive coefficient. Another cluster of southern and some northern states carry a significant
negative coefficient. These findings bear out those of Demirguc-Kant and Hugizinga on the
significance of the operating environment for bank efficiency. No sustainable improvement in
the performance efficiency of domestic banks is possible without prior improvement in the
enforcement environment in difficult regions of the country. Another finding of some
importance is that it is not foreign ownership in and itself so much as the banking efficiency
and technology correlates of the country of the origin of the foreign bank which determine
NPA performance in the Indian environment.


Chapter 2
Research
Methodology


Research Methodology
2.1 Statement of the problem
This report explores an empirical approach to the analysis of Non-Performing Assets (NPAs)
with special reference of South Indian bank in India. The NPAs are considered as an
important parameter to judge the performance and financial health of banks. The level of
NPAs is one of the drivers of financial stability and growth of the banking sector. This report
aims to find the fundamental factors which impact NPAs of banks. A model consisting of two
types of factors, viz., macroeconomic factors and bank-specific parameters, is developed and
the behavior of NPAs of the three categories of banks is observed. The empirical analysis
assesses how macroeconomic factors and bank-specific parameters affect NPAs of a
particular category of banks. The macroeconomic factors of the model included are GDP
growth rate and excise duty, and the bank-specific parameters are Credit Deposit Ratio
(CDR), loan exposure to priority sector, Capital Adequacy Ratio (CAR), and liquidity risk.
The results show that movement in NPAs over the years can be explained well by the factors
considered in the model for the public and private sector banks. The other important results
derived from the analysis include the finding that banks' exposure to priority sector lending
reduces NPAs
2.2) Research Objectives
To identify reasons that lead to NPAs.
To study the various provisions of the Act with special emphasis on reduction of NPAs.
To study why banks and financial institutions are facing the problem of swelling NPAs
even after the passing of the Act
To formulate methods for efficient recovery

2.3) : RESEARCH METHODOLOGY

The nature of research is exploratory as well as diagnostic as the study is aimed at exploring
the impact of securitization Act on the NPAs in the banking sector. This study is based on the
discussions conducted with officials of the bank. The various data provided by them, the RBI
circulars, journals, magazines, data from internet will be studied and interpretation made
thereof.
2.4) Sampling Design
Sampling unit - The sampling unit was banks especially the loan managers the credit
managers and the officers incharge of recovery department
The banks were chosen randomly
Sample size
The total sample size was five banks
2.5) Data Collection
Periodicals and journals
Websites.
2.6) Limitations of the study
Time constraint
Inadequate data
Cost constraints
Limited resources


2.7) Chapter scheme
The chapter scheme followed in this report is in the following manner:
1) Introduction
a) Background of the study:
b) NPA management biggest challenge for Banks in 2009
c) NPA in India Current Scenario
This chapter talks about the current scenario of NPA management with respect to
various banks in India.
2) Literature survey
a) NPA VARIATION ACROSS INDIAN COMMERCIAL BANKS
This chapter presents the findings of a formal attempt to explain inter bank variations
in NPAs for the year 1996-97.
3) Research Methodology
a) Statement of problem:
The main problem for which reason this particular research is being conducted is
mentioned in this part
b) Objectives of the study:
This sub-chapter contains the 4 objectives for which the research is being conducted
c) Sampling technique:
This contains details regarding various sampling design such as sample size, sampling
unit and sampling technique adopted
d) Data collection technique:
This tells us about the sources through which the data has been collected and what all
data have been collected for research purpose
e) Scope of the study:
This contains details regarding to what all areas and what time period this research is
restricted to
f) Limitations of the study:
Some of the major limitations of the study such as time constraint, cost constraints
have been listed

g) Chapter Scheme:
This gives the structure of how the report is framed chapter-wise and gives a gist
about what comes under each chapter
4) Industry Profile
a) This gives a brief about the Banking Industry which have been selected for research
purpose and also a gist about the NPA management across Banks of India.
5) Company Profile
a) This gives a brief about the South Indian Bank which have been selected for research
purpose as its awarded for Best NPA Management.
6) Analysis and interpretation
This part analysis the 5 banks on various parameters to find out how they are placed in
terms of business growth, efficiency and the comfort they provide in terms of their
current financial standing and business exposures.
7) Findings:
a) This part contains summary of findings of the entire report in which detail explanation
of Basel I and Basel II framework has also been highlighted.
8) Recommendations:
This chapter deals with the various suggestions and recommendations which have been
given based on the summary of findings

9) Bibliography:
This part contains the various sources from which data for the report has been collected
which includes journals, articles and websites

Chapter 3

Industry Profile
3.1 Company Profile

Established in 1929, South Indian Bank (SIB) got its status of Scheduled Bank in 1946. In
1960, SIB expanded by taking over 15 smaller banks. Presently, it has a network of 391
branches and 50 extension counters, spread over 10 States and 2 Union Territories.
Started as a private sector bank at Thrissur, a major town (now known as the Cultural Capital
of Kerala) to provide for the people a safe, efficient and service oriented repository of savings
of the community on one hand and to free the business community from the clutches of
greedy money lenders on the other by providing need based credit at reasonable rates of
interest. The bank in its 72 year long sojourn has been able to present itself as a vibrant, fast
growing, service oriented and trend setting financial intermediary.
In Dec. 1998, the Bank, for the first time made a public issue of 1,60,00,000 equity shares of
Rs.10/- each at a premium of Rs.22/- per share. ICICI, the premier DFI is the biggest share
holder of the Bank with the group company holding 11.38% of the banks equity.
SIB was the first among the Kerala based banks to offer a Credit Card to customers in Nov.
1992. Further the bank also has develop an in-house, a fully integrated branch automation
software.
During 2000-2001 the new product introduced were 'Gold Rush Scheme' and 'Siber Loan', the
former has been introduced for the benefit of traders and agriculturists while the latter has
been introduced for the general public and students. The bank recently introduce FINACLE,
an integrated, on-line enterprise banking solution designed to provide the 'e-platform' for
global banking industry developed by INFOSYS.
The Bank has joined hands with ICICI Prudential Ltd to market their life insurance products
through the Bank's branch network. It has also signed MOU with the Prudential ICICI Asset
Management Company Ltd to distribute their Mutual Fund products.

During 2005-06, the company came out with a Public Offer of 2,27,27,272 equity shares of
Rs.10/- each at a premium of Rs.56/- per share aggregating to Rs.150 Crores through book-
building route. ICICI Bank Ltd, a strategic investor in the bank made an exit from the bank
by divesting its entire shareholding in March 2006.
The Bank also became successful in changing its regional character into a national one by
opening new branches in three more States. The Branch network now covers 19 States and
Union Territories. During the current Fiscal 2005-2006, the Bank has opened 21 new
branches and 11 new Extension counters. At Present the Bank's branch network stands at 450
branches and 45 extension counters. The Bank has an ATM Network of 145 centre with a
card base of around 2,50,000.
The Bank has also obtained RBI Permission to open one more Regional Office at
Pathanamthitta, 18 new branches and 20 ATM centre which are expected to be opened in the
current year.
Vision Statement: To build a strong brand image to make the South Indian Bank technology
driven, customer oriented and the most preferred bank, where passion for excellence is a way
of life, innovation is a tradition, commitment to values is unshaken and customer loyalty is
abiding, enabling the Bank to achieve an impressive all round, (but better than the peer
group) business growth, build a healthy, qualitative and strong asset base and earn
commensurate profits.
Mission Statement: To become the most preferred and fastest growing among the Kerala
based banks, with a strong brand image as customer focused, technology driven and an
innovative bank with core competence in fostering relationship banking, garnering core
deposits with accent on cost, creating and maintaining high yielding quality assets through
focused marketing, qualitative appraisal and effective monitoring, ensuring a high level of
internal efficiency through impeccable housekeeping and enhancing shareholder value by
achieving the highest net profits amongst the peer group banks of Kerala.
Milestones:

The FIRST among the private sector banks in Kerala to become a scheduled bank in
1946 under the RBI Act.
The FIRST bank in the private sector in India to open a Currency Chest on behalf of
the RBI in April 1992.
The FIRST private sector bank to open a NRI branch in November 1992.
The FIRST bank in the private sector to start an Industrial Finance Branch in March
1993.
The FIRST among the private sector banks in Kerala to open an "Overseas Branch" to
cater exclusively to the export and import business in June 1993.
The FIRST bank in Kerala to develop an in-house, a fully integrated branch
automation software in addition to the in-house partial automation solution
operational since 1992.
The FIRST Kerala based bank to implement Core Banking System.
The THIRD largest branch network among Private Sector banks, in India, with all its
branches under Core banking System.
Effect of Financial Crisis
The major financial crisis of the 21st century involves esoteric instruments, unaware
regulators, and nervous investors.
Starting in the summer of 2007, the United States experienced a startling contraction in
wealth, triggered by the sub prime crisis, thereby leading to increase in risk spreads, and
decrease in credit market functioning. During boom years, mortgage brokers enticed by the
lure of big commissions, talked buyers with poor credit into accepting housing mortgages
with little or no down payment and without credit checks. Higher default levels, particularly
among less credit-worthy borrowers, magnified the impact of the crisis on the financial
sector.

The same financial crisis, which started last summer, is back with a vengeance. Paul
Krugman describes the analogy between credit lending between market players and the
financial markets, and motor oil to car engines. The ability to raise cash on short notice, i.e.
liquidity, is an essential lubricant for the markets and for the economy as a whole. The drying
liquidity has closed shops of a large number of credit markets. Interest rates have been rising
across the world, even rates at which banks lend to each other. The freezing up of the
financial markets will ultimately lead to a severe reduction in the rate of lending, followed by
slowed and drastically reduced business investments, leading to a recession, possibly a nasty
one.
A collapse of trust between market players has decreased the willingness of lending
institutions to risk money. The major reason behind this lack of trust being the bursting of the
housing bubble, which caused a lot of AAA labeled investments to turn out to be junk.
The IMF has warned the global economy of a spiraled mortgage crisis, starting in the United
States, ultimately leading to the largest financial shock since the Great Depression.
Since 1864, American Banking has been split into commercial banks and investment banks.
But now thats changing. Some of the biggest names on Wall Street, Bear Stearns, Lehman
Brothers, and Merrill Lynch, have disappeared into thin air overnight. Goldman Sachs and
Morgan Stanley are the only two giants left. Nervous investors have been sending markets
plunging down. Even Morgan Stanley, one of the last two big independent investment banks
on Wall Street, is struggling to survive at the exchange, though it insists that the company is
still in solid shape. Markets all over the world are confronted by all-time low figures in the
past couple of years or more, including those of Britain, Germany, and Asia.
In India, IT companies, with nearly half of their revenues coming from banking and financial
service segments, are close monitors of the financial crisis across the world. The IT giants
which had Lehman Brothers and Merrill Lynch as their clients are TCS, Wipro,
Satyam, and Infosys Technologies. HCL escaped the loss to a great extent because neither
Lehman Brothers nor ML was its client.
The government has a reason to worry because the ongoing financial crisis may have an
adverse impact on the banks. Lehman Brothers and Merrill Lynch had invested a substantial
amount in the stocks of Indian Banks, which in turn had invested the money in derivatives,
leading to the exposure of even the derivates market to these investment bankers.

The real estate sector is also affected due to the same factor. Lehman Brothers real estate
partner had given Rs. 7.40 crores to Unitech Ltd., for its mixed use development project in
Santa Cruz. Lehman had also signed a MoU with Peninsula Land Ltd, an Ashok Piramal real
estate company, to fund the latters project amounting to Rs. 576 crores. DLF Assets, which
holds an investment worth $200 million, is another major real estate organization whose
valuations are affected by the Lehman Brothers dissolution.
Britain has also witnessed the so called bursting of the Brown bubble, in the form of the
highest personal debt per capita in the G7 combined with an unsustainable rise in housing
prices. The longest period of expansion in the 21st century, which Britain claimed to be
ndergoing, eventually revealed itself of being an illusion. The illusion of rising to prosperity
has been maintained by borrowing to spend, often in the form of equity withdrawal from
increasing expensive houses. The bubble ultimately burst, exposing Britain to the most
serious financial crisis since the 1920s. This brings a lot of misery for home owners who are
set to see the cost of mortgages soar following the deepening of the banking crisis and the
Libor the rate at which banks lend to each other.
The impact of the crisis is more vividly observable in the emerging markets which are
suffering from one of their biggest sell-offs.
Everyone has exposure to everythingeither directly or indirectly, JP Morgan analyst,
Brian Johnson Economies with disproportionate offshore borrowings (like that of Australia)
are adversely affected by the western financial crunch. Globalization has ensured that none of
the economies of the world stay insulated from the present financial crisis in the developed
economies.
Analysis of the impact of the crisis on India can be on the basis of the following 3 criteria:
1. Availability of global liquidity
2. Demand for India investment and cost thereof
3. Decreased consumer demand affecting Indian exports
The main source of Indian prosperity was Foreign Direct Investment (FDI). American and
European companies were bringing in truck-loads of dollars and Euros to get a piece of the
pie of Indian prosperity. Less inflow of foreign investment will result in the dilution of the
element of GDP driven growth.

Liquidity is a major driving force of the strong market performances we have seen in
emerging markets. Markets such as those of India are especially dependent on global liquidity
and international risk appetite. While interest rates in some countries are increasing, countries
such as Brazil are decreasing interest rates. In general, rising interest rates tend to have a
negative impact on global liquidity and subsequently equity prices as fund may move into
bonds and other money markets.
Indian companies which had access to foreign funds for financing their import and export
will be worst hit Foreign funds will be available at huge premiums and will be limited only to
the blue-chip companies, thus leading to:
o Reduced capacity of expansion leading to supply side pressure
o Increased interest rates to affect corporate profitability
o Increased demand for domestic liquidity will put interest rates under pressure
Consumer demand will face a slow-down in developed economies leading to a reduce
demand for Indian goods and services, thus affecting Indian exports
o Export oriented units will be worst hit, thus impacting employment
o Widening of the trade gap due to reduced exports, leading to pressure on the rupee
exchange rate
Impact on Financial Markets:
o Equity market will continue to remain in bearish mood
o Demand for domestic liquidity will push interest rates high and as a result will lead to
rupee depreciation and depleted currency reserves
Every happy family is alike, but every unhappy family is unhappy in their own way. Leo
Tolstoy. While each financial crisis is undoubtedly distinct, there are also striking similarities
between them in growth patterns, debt accumulation, and in current account deficits.


Chapter - 4
Analysis & Interpretation


4.1 FINANCIAL OF SOUTH INDIAN BANK

PERFORMANCE OF SOUTH INDIAN BANK
The performance highlights of the bank for the financial year ended 31
st
March 2008 are as
follows:-
Rs. In Crores

The bank has registered a record Net profit of Rs. 151.62 crore. The Bank could achieve this
substantial improvement in Net profit mainly on account of higher scale of operations and
aggressive NPA recoveries.


SR.NO. KEY PARAMETERS 2007-08 2006-07

1 Deposits 15156 12239
2 Advances 10754 12239
3 Total Business 25910 20547
4 Net Profit 151.62 104.12
5 Net Worth 1160.98 723.96
6 Capital Adequacy (%) 13.8 11.08
7 Earning per share (in Rs.) 18.77* 14.79
8 Book Value per Share (in Rs.) 128.43 102.84
9
Net NPA as % of Net
Advances 0.33 0.98
10 Return on Assets (%) 1.01 0.88
4.2 OPERATING REVIEW- BUSINESS ACHIEVEMENT
DEPOSITS
The Bank could increase its total deposits to Rs. 15156 crore from Rs. 12239 crore last year
registering a growth of 23.83%
Break up of the deposits as on 31.03.2008 is as under
SR.No. PARTICULAR AMOUNT (in Crores) % to Total Deposits
1 Current Deposits 773.12 5.1
2 Saving Deposits 2875.72 18.97
3 Term Deposits 11507.28 75.93
TOTAL 15156.12 100

ADVANCES:-
Total advances of the Bank stood at Rs. 10754.36 crore registering a growth of 29.45% from
that of the previous year. Total Priority Sector Advances amounted to Rs. 3816.72 crore
which is 45.94 % of the Adjusted Net Bank Credit (ANBC) as at the end of the previous year,
sas against the target of 40% of the ANBC prescribed by Reserve Bank of India (RBI).
Exposure to Agricultural sector amounted to Rs.1489.05 crore forming 17.92% of the ANBC
as at the end of the previous year.
Split-up of exposure under Priority Sector is furnished below:
Amount (Rs. in crores)
Agriculture & Allied Activities: 1489.05
(Including eligible RIDF investments)
Small Enterprises: 738.46
Other Priority Sector: 1589.21

Total Priority Sector Advances: 3816.72
INVESTMENTS
The financial year saw RBI continuing its tight monetary policy. During the year, RBI hiked
Cash Reserve Ratio (CRR) by 125 basis points to 7.50% resulting in higher cost of funds to
the Bank. Ten year benchmark yield at the beginning and end of the financial year remained
unchanged at 7.93%. However during the course of the year, the ten-year yields had dropped
to a low of 7.50%.
The Stock markets showing a spectacular bull run upto December 2007 corrected very
sharply during the last quarter of the financial year with index losing nearly 25% of its gains.
The capital market also saw a number of companies coming out with Initial Public
Offers (IPOs) to augment their capital base and to benefit from the growing confidence of the
investors in the capital market during the earlier part of the year. The Bank actively
participated in primary market issues which has generated good income. The trading profit
during the year was Rs. 31.57 Crore by trading in equity, bonds, mutual funds, etc.
During the financial year, the gross investments increased from Rs.3457.00 crore to
Rs.4608.00 crore. The incremental investments were mainly due to increase in Statutory
Liquidity\ Ratio (SLR) requirements and Non-SLR investments, which are yielding higher
returns.
NON-PERFORMING ASSETS (NPA) MANAGEMENT
During the year 2007-08, the Bank had taken various steps for recovery of non-performing
assets and thereby contain the growth of NPAs. Conduct of recovery camps, issue of notice
under Securities and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002 (SARFAESI), one-time settlements, etc. were the major tools used by the Bank for
NPA recovery.

As a result of the various steps taken, the Bank could recover NPAs to the tune of Rs.172.31
crore during the year against the target of Rs. 130.00 crore. The Gross NPAs of the Bank as
on 31.03.2008 were Rs.188.48 crore as against Rs.321.21 crore as on 31.03.2007. The
percentage of Gross NPA to Gross Advances came down from 3.94% as on 31.03.2007 to
1.78% as on 31.03.2008.
The most notable achievement in NPA management was that the Bank could reduce the
percentage of net NPA to net Advances from 0.98% as on 31.03.2007 to 0.33% as on
31.03.2008.
CAPITAL ADEQUACY
SR.NO. ITEMS 31.03.2008 31.03.2007
1
Capital to Risk Weighted Asset Ratio
(CRAR%) 13.8 11.08
2 CRAR- Tier I Capital (%) 12.08 8.84
3 CRAR- Tier II Capital (%) 1.72 2.24
4
% of shareholding of GOI in Nationalised
Bank NA NA
5
Amt of subordinated debt raised during the
year as Tier II Capital ( Rs in Lakhs NIL NIL

BUSINESS RATIOS / INFORMATION
SR.NO. ITEMS 31.03.2008 31.03.2007
1
Interest Income as a percentage to working
funds 8.70% 8.26%
2
Non- interest income as a percentage to
working funds 0.83% 0.87%
3
Operating profit as a percentage to working
funds 1.80% 2.13%
4 Return on Assets 1.01% 0.88%
5
Business( Deposits plus Advances) per
employee 600.00 508.00
6 Profit per employee (Rs. In Lakhs) 3.59 2.69


NON PERFORMING NON-SLR INVESTMENT
SR.NO. ITEMS 31.03.2008 31.03.2007
Opening Balance 1225.25 1517.89

Additions during the year since 1st April
2007/2006 NA 200
Reductions during the above period 100 492.64
Closing balance 1125.25 1225.25
Total provisions held 1045.25 1135.25

Asset quality
Percentage of net NPAs to net advances works out to 0.33% (0.98 % as on 31.03.2007).
Provision for Non-Performing Advances and unrealised interest thereon are deducted from
various categories of advances on a proportionate basis except the Provision for Standard
Assets, which is included under "Other Liabilities".

MOVEMENTS IN NON PERFORMING ASSETS
SR.NO. ITEMS 2008 2007
1 Net NPAs to Net Advances [%] 0.33 0.98
2 Movement of NPAs (Gross)
(a) Opening Balance 32121 32782
(b) Additions during the year 5795 14434
(c) Reductions during the year 19068 15095
(d) Closing Balance 18848 32121
3 Movement of NPAs (Net)
(a) Opening Balance 7781 11820
(b) Additions during the year 2627 8647
(c) Reductions during the year 7011 12686
4
Movement of provisions for NPAs
(excluding provisions on standard assets)
(a) Opening Balance 23247 20025.06
(b) Additions during the year 1406 8228.24
(c) Reductions during the year 10342 5006.3

4.3 Financial Results 2008-09
The net profit of South Indian Bank has grown by 28 percent to Rs 194.75 crore ( Rs. 151.62
crore last year) for the year 2008-09. Despite the adverse economic environment prevailing
over the economy in general and the financial sector in particular, the bank was able to
surpass the profit targets set for the year.
This performance reported by the bank is encouraging and it demonstrates our continuing
commitment to delivering sustainable result Dr. V.A. Joseph, Managing Director andnCEO,
said. The board has recommended a 20 % dividend.
The bank had made a concerted effort to shore up the current and savings account portfolio
during the year which resulted in the net interest margin improving from 2.62 per cent to 2.92
percent. The bank was able to add 6.5lakh new savings and current account deposits during
the year. The banks aggregate business volumes surpassed the Rs 30,000 crore mark and
touched Rs. 30, 327 crore Rs 18,902 crore by way of deposits and Rs. 12,145 crore in
advances. The return on average assets improved from 1.01 per cent to 1.09 percent during
the year.


Sr.No. PARTICULAR 2008-09 2007-08
1 Net Profit 194.75 151.62
2 Operating Profit 358.67 273.35
3 Net Interest Income 522.88 376.14
4
ii) Capital Adequacy Ratio
(%) a) BASEL I
13.89 13.80
5 BASEL II 14.76 N A
6
iv) NPA Ratios (a) Gross
NPA
26056 18848
7
Net NPA 13431 3397
8 (b) % of Gross NPA 2.18 1.78
9
% of Net NPA 1.13 0.33
10 (c) Return on Assets 0.26 * 0.29 *

4.4 Comparison
Comparison of banks on various parameters
I analysed the above banks on various parameters to find out how they are placed in terms of
business growth, efficiency and the comfort they provide in terms of their current financial
standing and business exposures.
The growth-related variables indicate the last 5-year CAGR banks achieved in advances and
deposits. ICICI Bank was an out performer in Loan growth and Deposit growth compares to
other banks.

On efficiency-related parameters, the cost/income ratio, quality of advances and the extent of
loan loss-loss provision coverage have been reviewed. South Indian Bank has lent out more
of unsecured loan when compared to the total loan.
Also, we analysed banks that generate the maximum core interest income as a proportion of
total income. ICICI Bank and Axis Bank have greater proportions of their income coming
from 'other income' and these segments might have greater tendency to show slower growth
in the current scenario. A detailed analysis of the above parameters is presented in the
ensuing paragraphs.
GROWTH METRIC Loan Growth Comparison
The chart below shows that the last 5years loan growth achieved by Indians Major Bank.
HDFC Bank & ICICI Bank showed consistent growth over the last 3years( even though it
shows slightly falling trend in the last 5years.)
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
100.00
HDFC BANK ICICI BANK AXIS BANK BANK OF
BARODA
SOUTH
INDIAN BANK
Series1
Series2
Series3
Series4

GROWTH METRIC- Deposit Growth CAGR

In terms of deposit growth CAGR achieved by these banks during the last 5years,
ICICIBANK and AXIS BANK retain top their deposit growth and showed a constant
increase
0.00
20.00
40.00
60.00
80.00
100.00
120.00
BARODA
SOUTH INDIAN
BANK
Series1
Series2
Series3
Series4

Unsecured Loan as % of Total Loan
Unsecured Loan primarily includes personal loans, credit card exposure, priority sector
lending in rural areas, education loans, credits to SMEs( small and medium entrepreneurs)
up to Rs. 5lakh, etc. Exposure of India Bank towards unsecured loan rose consistently over
the years. As shown in the chart below, Bank of Baroda and South Indian Bank has the
highest of its total loans exposed to unsecured loans.
0
10
20
30
40
50
60
70
1 2 3 4 5
HDFC BANK
ICICI BANK
AXIS BANK
BOB
SOUTH INDIAN BANK


Though there is no direct correlation between loan losses and unsecured loan exposure, in an
economic slowdown scenario, such exposure will carry a greater stress, and hence, a higher
probability of default. Banks need to be extremely vigilant in terms of monitoring these loans
regularly, so that losses in the form of NPAs do not increase unreasonably and dent the
quality of the loan book.
However, a review of the gross NPA ratio, i.e., GNPA as a percentage of advances indicates
that HDFC Bank & South Indian Bank have ensured that the NPA increase is proportionate
to that of the loan growth. In fact, PSU banks have shown tremendous improvement in terms
of loan quality, as the GNPA ratio for these banks fell from average 8-9% levels to less than
3% levels in the last 5 years. Only ICICI Bank has shown deterioration of its loan quality as
reflected in its increasing GNPA ratio. The main reason for this increase is that the bank has
substantial exposure to the retail segment, including huge exposure to the real estate segment
at almost 36% of total loans that includes close to 30% exposure in the form of housing loans.
The retail segment constitutes close to 75% of ICICI Bank's NPAs.
GROSS NON PERFORMING ASSETS
0
1000
2000
3000
4000
5000
6000
7000
8000
1 2 3 4 5
HDFC BANK
ICICI BANK
AXIS BANK
BANK OF BARODA
SOUTH INDIAN BANK

COST INCOME RATIO

In terms of control over costs, the below table explains cost/income ratios of these banks over
the last 5 years. At the end of FY08, all banks have a similar cost/income ratio averaging
between 30-25%.
0
5
10
15
20
25
30
35
BARODA
SOUTH INDIAN
BANK
Series1
Series2
Series3
Series4
Series5

4.5 Basel Report Framework and India
RISK MANAGEMENT AND BASEL II
In the present volatile and rapidly changing financial scenario, it is very challenging for the
banks to manage complex and variable risks in a disciplined manner. It is imperative to have
good risk management practices not only to manage risks inherent in the banking business
but also to face the risks emanating from financial markets as a whole. The Bank aims to put
in place the best risk management structure which proactively identifies and helps in
controlling the various risks faced by the Bank, while maintaining proper trade off between
risk and return thereby maximising the shareholder value.
The Bank's risk management structure is overseen by the Board of Directors and appropriate
policies to manage various types of risk are approved by the sub committee of the Board. The
subcommittee of the Board also provides strategic guidance while reviewing portfolio
behaviour. Senior level Management Committees like Credit Risk Management Committee,
Operational Risk Management Committee, Investment Committee, Asset Liability
Management Committee, etc. develop and implement the risk policies.


BASEL II
The growing concern and recognition of limitation of Basel I which largely ignored both the
heterogeneity of the asset class and its differential risk sensitivity, led to the emergence of a
new accord, Basel II. Basel II encompasses all three risks inherent in the business
1. Credit Risk
2. Market Risk
3. Operational Risk
of which the most difficult and hence controversial part has been assessment , measurement
and quantification of Operational Risk.
CREDIT RISK
The Bank is exposed to credit risks through its lending and investment activities. The credit
risk management frameworks integrate both qualitative and quantitative processes to support
growth in the asset book while ensuring an acceptable risk level in relation to the return. The
aim of credit risk management in this year has been to maintain a healthy credit portfolio in
the Bank. In line with the above goal, the Bank has strengthened its risk management
processes by fine tuning its internal rating models for measuring credit risk and internal rating
migration study to review the risk at the portfolio level and analyse the portfolio behaviour.
As a measure towards credit risk mitigation, Bank has strengthened the Credit Sanction and
Credit Monitoring departments by inducting more expert and experienced personnel. Credit
risks inherent in investments in Non SLR Bonds are being assessed independently by Mid
office Treasury using the internal rating models developed by Integrated Risk Management
Department (IRMD). Minimum entry level rating for external and internal rating are
prescribed in Investment Policy for investments in Non SLR Bonds. Moreover, to strengthen
the risk management system, it is proposed that the internal rating done by mid offices shall
be independently confirmed by IRMD in the proposed Market Risk Management (MRM)
policy.
MARKET RISK

Market risk results from changes in market value of assets arising due to volatility of market
risk factors and their probable impact on income and economic value for the aggregate
banking and trading books, due to Asset- Liability mismatches. The Bank adopts a
comprehensive approach to manage market risk for its trading and banking book. The market
risk framework identifies the types of market risks to be covered, the risk metrics and
methodologies to be used to capture such risks and the standards governing the management
of market risk including limit setting. Market risk measurement on portfolios uses both
statistical and non-statistical measures to monitor risks with triggers in cases of breaches in
the pre-accepted levels of identified risks.
The Bank is also using Value at Risk measure, which provides valuable insights into the risk
profile of the Bank's exposures. Regular stress testing is carried out to monitor the Bank's
vulnerability to shocks and the impact of extreme market movements. Risk limits for trading
book are set according to a number of criteria including market analysis, business strategy,
management experience and the Bank's risk appetite.
LIQUIDITY RISK
Liquidity obligations of the Bank arise from withdrawal of deposits, repayment of purchased
funds at maturity, extension of credit and working capital needs. The primary tool of
monitoring liquidity is the mismatch analysis, which is monitored over successive time bands
on a static basis. The liquidity profile of the Bank is also estimated on a more dynamic basis
by considering the growth in deposits and advances, investments, etc, for a short term period
of 90 days. Stress tests are conducted in periodic intervals to test the Bank's ability to meet
the obligation in a crisis scenario and to assess the impact on the Bank's liquidity to withstand
stressed conditions. These positions are reviewed periodically by the Bank's Asset Liability
Management Committee.
OPERATIONAL RISK

A policy on management of operational risk has been approved by the Bank to ensure that the
operational risk within the Bank is properly identified, monitored and reported in a structured
manner. Bank's Operational Risk Management Committee oversees application of the above
said policy directives. Each new product or service introduced is subject to risk review and
sign-off process where all relevant risks are identified and assessed by departments
independent of the risk taking unit proposing the product. The losses due to technical failures
and business disruptions are mitigated through adequate back up facilities, the existence of
disaster setup and regular testing rolled over by the Information Technology Division (ITD).
The Bank has started computing capital charge under Basel II parallel run as required by RBI
guidelines for Credit, Market and Operational risks from June 2006. Bank has fine tuned its
Basel II parallel run by adopting various credit risk mitigation strategies aided by improved
MIS systems during the year which has improved the CRAR of the Bank under Basel II.
Further, Bank had appointed a consultant during the year, who is experienced in the Risk
Management and Basel II implementation to review risk management processes and the
parallel run under Basel II adopted by the Bank. The consultants have completed their
assignments and submitted their suggestions / recommendations on various areas of risk
management during the year and the Bank is in the process of further fine-tuning the system
based on the consultant's recommendations. The Bank has geared up to be Basel II compliant
by 31.03.2009 as prescribed by RBI.
Various risks in bank
Interest Rate Risk (IRR) is the exposure of a Banks financial condition to adverse
movements in interest rates. Banks have an appetite for this risk and use it to earn returns.
IRR manifests itself in four different ways: re-pricing, yield curve, basis and embedded
options.
Pricing Risk is the risk to the banks financial condition resulting from adverse movements in
the level or volatility of the market prices of interest rate instruments, equities, commodities
and currencies. Pricing Risk is usually measured as the potential gain/loss in a
position/portfolio that is associated with a price movement of a given probability over a
specified time horizon. This measure is typically known as value-at risk (VAR).
Foreign Currency Risk is pricing risk associated with foreign currency.
The term Market Risk applies to (i) that part of IRR which affects the price of interest rate
instruments, (ii) Pricing Risk for all other assets/portfolio that are held in the trading book of
the bank and (iii) Foreign Currency Risk.
Strategic Risk is the risk arising from adverse business decisions, improper implementation
of decisions, or lack of responsiveness to industry changes. This risk is function of the
compatibility of an organizations strategic goals, the business strategies developed to
achieve those goals, the resources deployed against these goals, and the quality of
implementation.

Reputation risk is the risk arising from negative public opinion. This risk may expose the
institution to litigation, financial loss, or a decline in customer base.
Transaction risk is the risk arising from fraud, both internal & external, failed business
processes and the inability to maintain business continuity and manage information.
Compliance risk is the risk of legal or regulatory sanctions, financial loss or reputation loss
that a bank may suffer as a result of its failure to comply with any or all of the applicable
laws, regulations, and codes of conduct and standards of good practice. It is also called
integrity risk since a banks reputation is closely linked to its adherence to principles of
integrity and fair dealing.
Credit Risk is most simply defined as the potential of a bank borrower or counter-party to fail
to meet its obligations in accordance with agreed terms. For most banks, loans are the largest
and most obvious source of credit risk.
4.6 Banking Regulation and Supervision
The Need for Regulation
Banking is one of the most heavily regulated businesses since it is a very highly leveraged
(high debt-equity ratio or low capital-assets ratio) industry. In fact, it is an irony that banks,
which constantly judge their borrowers on debt-equity ratio, have themselves a debt-equity
ratio far too adverse than their borrowers! In simple words, they earn by taking risk on their
creditors money rather than shareholders money. And since it is not their money
(shareholders stake) on the block, their appetite for risk needs to be controlled.
Goals and Tools for Bank Regulation and Supervision

The main goal of all regulators is the stability of the banking system. However regulators
cannot be concerned solely with the safety of the banking system, for if that was the only
purpose, it would impose a narrow banking system, in which checkable deposits are fully
backed by absolutely safe assets in the extreme, currency. Coexistent with this primary
concern is the need to ensure that the financial system operates efficiently. As we have seen,
banks need to take risks to be in business despite a probability of failure. In fact, Alan
Greenspan puts it very succinctly, `providing institutions with the flexibility that may lead to
failure is as important as permitting them the opportunity to succeed. The twin supervisory
or regulatory goals of stability and efficiency of the financial system often seem to pull in
opposite directions and there is much debate raging on the nature and extent of the trade-off
between the two. Though very interesting, it is outside the scope of this report to elaborate
upon. Instead, let us take a look at the list of some tools that regulators employ:
Restrictions on bank activities and banking-commerce links: To avoid conflicts of interest
that may arise when banks engage in diverse activities such as securities underwriting,
insurance underwriting, and real estate investment.
Restrictions on domestic and foreign bank entry: The assumption here is that effective
screening of bank entry can promote stability.
Capital Adequacy: Capital serves as a buffer against losses and hence also against failure.
Capital adequacy is deemed to control risk appetite of the bank by aligning the incentives of
bank owners with depositors and other creditors.
Deposit Insurance: Deposit insurance schemes are to prevent widespread bank runs and to
protect small depositors but can create moral hazard (which means in simple terms the
propensity of both firms and individuals to take more risks when insured).
Information disclosure & private sector monitoring: Includes certified audits and/or ratings
from international rating agencies. Involves directing banks to produce accurate,
comprehensive and consolidated information on the full range of their activities and risk
management procedures.
Government Ownership: The assumption here is that governments have adequate
information and incentives to promote socially desirable investments and in extreme cases
can transfer the depositors loss to tax payers! Government ownership can, at times, promote
financing of politically attractive projects and not the economically efficient ones.
Mandated liquidity reserves: To control credit expansion and to ensure that banks have a
reasonable amount of liquid assets to meet their liabilities.

Loan classification, provisioning standards & diversification guidelines: These are controls
to manage credit risk. Unfortunately, however, there is no evidence that any universal set of
best practices is appropriate for promoting well-functioning banks; that successful practices
in the United States, for example, will succeed in countries with different institutional
settings; or that detailed regulations and supervisory practices should be combined to produce
an extensive checklist of best practices in which more checks are better than fewer. There is
no broad cross-country evidence on which of the many different regulations and supervisory
practices employed around the world work best, if at all, to promote bank development and
stability.
4.7The Basel I Accord
Basel Committee on Banking Supervision (BCBS)
On 26th June 1974, a number of banks had released Deutschmarks to Bank Herstatt in
Frankfurt in exchange for dollar payments that were to be delivered in New York. Due to
differences in time zones, there was a lag in dollar payments to counter-party banks during
which Bank Herstatt was liquidated by German regulators, i.e. before the dollar payments
could be affected.
The Herstatt accident prompted the G-10 countries (the G-10 is today 13 countries: Belgium,
Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Spain, Sweden,
Switzerland, United Kingdom and United States) to form, towards the end of 1974, the Basel
Committee on Banking Supervision (BCBS), under the auspices of the Bank for International
Settlements (BIS), comprising of Central Bank Governors from the participating countries.
BCBS has been instrumental in standardizing bank regulations across jurisdictions with
special emphasis on defining the roles of regulators in cross-jurisdictional situations. The
committee meets four times a year. It has around 30 technical working groups and task forces
that meet regularly.
1988 Basel Accord
In 1988, the Basel Committee published a set of minimal capital requirements for banks,
known as the 1988 Basel Accord. These were enforced by law in the G-10 countries in 1992,
with Japanese banks permitted an extended transition period.

The 1988 Basel Accord focused primarily on credit risk. Bank assets were classified into five
risk buckets i.e. grouped under five categories according to credit risk carrying risk weights
of zero, ten, twenty, fifty and one hundred per cent. Assets were to be classified into one of
these risk buckets based on the parameters of counter-party (sovereign, banks, public sector
enterprises or others), collateral (e.g. mortgages of residential property) and maturity.
Generally, government debt was categorised at zero per cent, bank debt at twenty per cent,
and other debt at one hundred per cent. 100%. OBS exposures such as performance
guarantees and letters of credit were brought into the calculation of risk weighted assets using
the mechanism of variable credit conversion factor. Banks were required to hold capital equal
to 8% of the risk weighted value of assets. Since 1988, this framework has been progressively
introduced not only in member countries but also in almost all other countries having active
international banks. The 1988 accord can be summarized in the following equation:
Total Capital = 0.08 x Risk Weighted Assets (RWA)
The accord provided a detailed definition of capital. Tier 1 or core capital, which includes
equity and disclosed reserves, and Tier 2 or supplementary capital, which could include
undisclosed reserves, asset revaluation reserves, general provisions & loanloss reserves,
hybrid (debt/equity) capital instruments and subordinated debt.
Value at Risk (VAR)
VAR is a method of assessing risk that uses standard statistical techniques and provides users
with a summary measure of market risk. For instance, a bank might say that the daily VAR of
its trading portfolio is rupees 20 million at the 99 per cent confidence level.
In simple words, there is only one chance in 100, under normal market conditions, for a loss
greater than rupees 20 million to occur. This single number summarizes the bank's exposure
to market risk as well as the probability (one per cent, in this case) of it being exceeded.
Shareholders and managers can then decide whether they feel comfortable at this level of
risk. If not, the process that led to the computation of VAR can be used to decide where to
trim risk.
Now the definition; VAR summarizes the predicted maximum loss (or worst loss) over a
target horizon within a given confidence interval. Target horizon means the period till which
the portfolio is held. Ideally, the holding period should correspond to the longest
period needed for an orderly (as opposed to a `fire sale) portfolio liquidation.
Without going into the related math, it should be mentioned here that there exist three
methods of computing VAR, viz. Delta-Normal, Historical Simulation and Monte Carlo
Simulation, the last one being the most computation intensive and predictably the most
sophisticated one.

In a lighter vein, a definition of VAR that was found at the gloriamundi.org web site said, À
number invented by purveyors of panaceas for pecuniary peril intended to mislead senior
management and regulators into false confidence that market risk is adequately understood
and controlled.
1996 Amendment to include Market Risk
In 1996, BCBS published an amendment to the 1988 Basel Accord to provide an explicit
capital cushion for the price risks to which banks are exposed, particularly those arising from
their trading activities. This amendment was brought into effect in 1998.
Salient Features
Allows banks to use proprietary in-house models for measuring market risks.
Banks using proprietary models must compute VAR daily, using a 99th percentile, one
tailed confidence interval with a time horizon of ten trading days using a historical
observation period of at least one year.
The capital charge for a bank that uses a proprietary model will be the higher of the
previous day's VAR and three times the average of the daily VAR of the preceding sixty
business days.
Use of `back-testing (ex-post comparisons between model results and actual performance)
to arrive at the `plus factor that is added to the multiplication factor of three.
Allows banks to issue short-term subordinated debt subject to a lock-in clause (Tier 3
capital) to meet a part of their market risks.
Alternate standardized approach using the `building block approach where general market
risk and specific security risk are calculated separately and added up.
Banks to segregate trading book and mark to market all portfolio/position in the trading
book.
Applicable to both trading activities of banks and non-banking securities firms.


Evolution of Basel Committee Initiatives

The Basel I Accord and the 1996 Amendment thereto have evolved into Basel II, as depicted
in the figure above.
4.8 The New Accord (Basel II)
Close on the heels of the 1996 amendment to the Basel I accord, in June 1999 BCBS issued a
proposal for a New Capital Adequacy Framework to replace the 1988 Accord. The proposed
capital framework consists of three pillars: minimum capital requirements, which seek to
refine the standardised rules set forth in the 1988 Accord; supervisory review of an
institution's internal assessment process and capital adequacy; and effective use of disclosure
to strengthen market discipline as a complement to supervisory efforts.

The accord has been finalized recently on 11th May 2004 and the final draft is expected by
the end of June 2004. For banks adopting advanced approaches for measuring credit and
operational risk the deadline has been shifted to 2008, whereas for those opting for basic
approaches it is retained at 2006.

The Need for Basel II
The 1988 Basel I Accord has very limited risk sensitivity and lacks risk differentiation
(broad brush structure) for measuring credit risk. For example, all corporations carry the
same risk weight of 100 per cent. It also gave rise to a significant gap between the
regulatory measurement of the risk of a given transaction and its actual economic risk. The
most troubling side effect of the gap between regulatory and actual economic risk has been
the distortion of financial decision-making, including large amounts of regulatory arbitrage,
or investments made on the basis of regulatory constraints rather than genuine economic
opportunities. The strict rule based approach of the 1988 accord has also been criticised for
its òne size fits all prescription. In addition, it lacked proper recognition of credit risk
mitigants such as credit derivatives, securitisation, and collaterals.

The recent cases of frauds, acts of terrorism, hacking, have brought into focus the operational
risk that the banks and financial institutions are exposed to. The proposed new accord (Basel
II) is claimed by BCBS to be àn improved capital adequacy framework intended to foster a
strong emphasis on risk management and to encourage ongoing improvements in banks risk
assessment capabilities. It also seeks to provide a `level playing field for international
competition and attempts to ensure that its implementation maintains the aggregate regulatory
capital requirements as obtaining under the current accord. The new framework deliberately
includes incentives for using more advanced and sophisticated approaches for risk
measurement and attempts to align the regulatory capital with internal risk measurements of
banks subject to supervisory review and market disclosure.
PILLAR I:
Minimum Capital Requirements
There is a need to look at proposed changes in the measurement of credit risk and operational
risk

Credit Risk
Three alternate approaches for measurement of credit risk have been proposed. These are:
Standardised
Internal Ratings Based (IRB) Foundation
Internal Ratings Based (IRB) Advanced

The standardised approach is similar to the current accord in that banks are required to slot
their credit exposures into supervisory categories based on observable characteristics of the
exposures (e.g. whether the exposure is a corporate loan or a residential mortgage loan). The
standardised approach establishes fixed risk weights corresponding to each supervisory
category and makes use of external credit assessments to enhance risk sensitivity compared
to the current accord. The risk weights for sovereign, inter-bank, and corporate exposures are
differentiated based on external credit assessments. An important innovation of the
standardised approach is the requirement that loans considered `past due be risk weighted at
150 per cent unless, a threshold amount of specific provisions has already been set aside by
the bank against that loan.
Credit risk mitigants (collaterals, guarantees, and credit derivatives) can be used by banks
under this approach for capital reduction based on the market risk of the collateral instrument
or the threshold external credit rating of recognised guarantors. Reduced risk weights for
retail exposures, small and medium size enterprises (SME) category and residential
mortgages have been proposed. The approach draws a number of distinctions between
exposures and transactions in an effort to improve the risk sensitivity of the resulting capital
ratios.
The IRB approach uses banks internal assessments of key risk drivers as primary inputs to
the capital calculation. The risk weights and resultant capital charges are determined through
the combination of quantitative inputs provided by banks and formulae specified by the
Committee. The IRB calculation of risk weighted assets for exposures to sovereigns, banks,
or corporate entities relies on the following four parameters:
Probability of default (PD), which measures the likelihood that the borrower will default
over a given time horizon.
Loss given default (LGD), which measures the proportion of the exposure that will be lost if
a default occurs.
Exposure at default (EAD), which for loan commitment measures the amount of the
facility that is likely to be drawn in the event of a default.
Maturity (M), which measures the remaining economic maturity of the exposure.
Operational Risk
Within the Basel II framework, operational risk is defined as the risk of losses resulting from
inadequate or failed internal processes, people and systems, or external events.

Operational risk identification and measurement is still in an evolutionary stage as compared
to the maturity that market and credit risk measurements have achieved.
As in credit risk, three alternate approaches are prescribed:
Basic Indicator
Standardised
Advanced Measurement (AMA)
PILLAR 2:
Supervisory Review Process
Pillar 2 introduces two critical risk management concepts: the use of economic capital, and
the enhancement of corporate governance, encapsulated in the following four principles:
Principle 1: Banks should have a process for assessing their overall capital adequacy in
relation to their risk profile and a strategy for maintaining their capital levels.
The key elements of this rigorous process are:
Board and senior management attention;
Sound capital assessment;
Comprehensive assessment of risks;
Monitoring and reporting; and
Internal control review.
Principle 2: Supervisors should review and evaluate banks internal capital adequacy
assessments and strategies, as well as their ability to monitor and ensure their compliance
with regulatory capital ratios. Supervisors should take appropriate supervisory action if they
are not satisfied with the result of this process.
This could be achieved through:
On-site examinations or inspections;

Off-site review;
Discussions with bank management;
Review of work done by external auditors; and
Periodicreporting.
Principle 3: Supervisors should expect banks to operate above the minimum regulatory
capital ratios and should have the ability to require banks to hold capital in excess of the
minimum.
Principle 4: Supervisors should seek to intervene at an early stage to prevent capital from
falling below the minimum levels required to support the risk characteristics of a particular
bank and should require rapid remedial action if capital is not maintained or restored.
Prescriptions under Pillar 2 seek to address the residual risks not adequately covered under
Pillar 1, such as concentration risk, interest rate risk in banking book, business risk and
strategic risk. `Stress testing is recommended to capture event risk. Pillar 2 also seeks to
ensure that internal risk management process in the banks is robust enough. The combination
of Pillar 1 and Pillar 2 attempt to align regulatory capital with economic capital.
PILLAR 3:
Market Discipline
The focus of Pillar 3 on market discipline is designed to complement the minimum capital
requirements (Pillar 1) and the supervisory review process (Pillar 2). With this, the Basel
Committee seeks to enable market participants to assess key information about a banks risk
profile and level of capitalizationthereby encouraging market discipline through increased
disclosure. Public disclosure assumes greater importance in helping banks and supervisors to
manage risk and improve stability under the new provisions which place reliance on internal
methodologies providing banks with greater discretion in determining their capital needs.
There has been some confusion on the extent, medium, confidentiality and materiality of such
disclosures. It has been agreed that such disclosures will depend on the legal authority and
accounting standards existing in each country. Efforts are in progress to harmonise these
disclosures with International Financial Reporting Standards (IFRS) Board Standards
(International Accounting Standards 30 & 32).

Chapter - 5
Findings, Conclusion
And
Suggestions


The issue of Non-Performing Assets (NPAs) in the financial sector has been an area of
concern for all economies and reduction in NPAs has become synonymous with functional
efficiency of financial intermediaries. Although NPAs are a balance sheet issue of individual
banks and financial institutions, it has wider macroeconomic implications. It is important
that, if resolution strategies for recovery of dues from NPAs are not put in place quickly and
efficiently, these assets would deteriorate in value over time and only scrap value would be
realized at the end. It should, however, be kept in mind that NPAs are an integral part of the
business financial sector and the players are in as they are in the business of taking risk and
their earnings reflect the risk they take. They operate in an environment, where there would
be defaults as well as deterioration in portfolio value, as market movements can never be
predicted with certainty. It is in this context, that countries have adopted regulatory measures
and the guiding structure has been provided by the Basel guidelines.
There are various reasons for assets turning non-performing and there can be alternative
resolution strategies. Identification of the reasons and timely action are the key to improved
profitability of financial sector intermediaries. In this context, the details of the CAMEL
model that RBI introduced for evaluating performance of banks and the need for this arose
from the systemic generation of large volume of NPAs. CAMEL covers capital adequacy,
asset quality, management quality, earnings ability and liquidity.


Indian economy and NPAs
Undoubtedly the world economy has slowed down, recession is at its peak, globally stock
markets have tumbled and business itself is getting hard to do. The Indian economy has been
much affected due to high fiscal deficit, poor infrastructure facilities, sticky legal system,
cutting of exposures to emerging markets by FIIs, etc.
Further, international rating agencies like, Standard & Poor have lowered India's credit rating
to sub-investment grade. Such negative aspects have often outweighed positives such as
increasing forex reserves and a manageable inflation rate.
Under such a situation, it goes without saying that banks are no exception and are bound to
face the heat of a global downturn. One would be surprised to know that the banks and
financial institutions in India hold non-performing assets worth Rs. 1, 10,000 Crores. Bankers
have realized that unless the level of NPAs is reduced drastically, they will find it difficult to
survive.
Global Developments and NPAs
The core banking business is of mobilizing the deposits and utilizing it for lending to
industry. Lending business is generally encouraged because it has the effect of funds being
transferred from the system to productive purposes which results into economic growth.
However lending also carries credit risk, which arises from the failure of borrower to fulfill
its contractual obligations either during the course of a transaction or on a future obligation.
A question that arises is how much risk can a bank afford to take ? Recent happenings in the
business world - Enron, WorldCom, Xerox, Global Crossing do not give much confidence to
banks. In case after case, these giant corporates became bankrupt and failed to provide
investors with clearer and more complete information thereby introducing a degree of risk
that many investors could neither anticipate nor welcome. The history of financial institutions
also reveals the fact that the biggest banking failures were due to credit risk.

Due to this, banks are restricting their lending operations to secured avenues only with
adequate collateral on which to fall back upon in a situation of default. Performance in terms
of profitability is a benchmark for any business enterprise including the banking industry.
However, increasing NPAs have a direct impact on banks profitability as legally banks are
not allowed to book income on such accounts and at the same time banks are forced to make
provision on such assets as per the Reserve Bank of India (RBI) guidelines. Reserve Bank of
India (RBI) has issued guidelines on provisioning requirement with respect to bank advances.
In terms of these guidelines, bank advances are mainly classified into:
Standard Assets: Such an asset is not a non-performing asset. In other words, it carries not
more than normal risk attached to the business.
Sub-standard Assets: Which has remained NPA for a period less than or equal to 12 months.
Doubtful Assets: This has remained in the sub-standard category for a period of 12 months
Loss Assets: Here loss is identified by the banks concerned or by internal auditors or by
external auditors or by Reserve Bank India (RBI) inspection.
In terms of RBI guidelines, as and when an asset becomes a NPA, such advances would be
first classified as a sub-standard one for a period that should not exceed 12 months and
subsequently as doubtful assets.
It should be noted that the above classification is only for the purpose of computing the
amount of provision that should be made with respect to bank advances and certainly not for
the purpose of presentation of advances in the banks balance sheet.
Provision
Standard Assets general provision of a minimum of 0.25%
Substandard Assets 10% on total outstanding balance, 10 % on unsecured exposures
identified as sub-standard & 100% for unsecured doubtful assets.
Doubtful Assets 100% to the extent advance not covered by realizable value of security.
In case of secured portion, provision may be made in the range of 20% to 100% depending on
the period of asset remaining sub-standard
Loss Assets 100% of the outstanding


FINDINGS:-
Management of NPA
During initial sage the percentage of NPA was higher. This was due to show ineffective
recovery of bank credit, lacuna in credit recovery system, inadequate legal provision etc.
Various steps have been taken by the government to recover and reduce NPAs.
Some of them are.
Formation of the Credit Information Bureau (India) Limited (CIBIL)
Release of Wilful Defaulters List. RBI also releases a list of borrowers with aggregate
outstanding of Rs.1 crore and above against whom banks have filed suits for recovery of their
funds
Reporting of Frauds to RBI
Norms of Lenders Liability framing of Fair Practices Code with regard to lenders
liability to be followed by banks, which indirectly prevents accounts turning into NPAs on
account of banks own failure
Risk assessment and Risk management
RBI has advised banks to examine all cases of wilful default of Rs.1 crore and above and
file suits in such cases. Board of Directors are required to review NPA accounts of Rs.1 crore
and above with special reference to fixing of staff accountability.
Reporting quick mortality cases
Special mention accounts for early identification of bad debts. Loans and advances overdue
for less than one and two quarters would come under this category. However, these accounts
do not need provisioning
NPA MANAGEMENT - RESOLUTION
Compromise Settlement Schemes

Restructuring / Reschedulement
Lok Adalat
Corporate Debt Restructuring Cell
Debt Recovery Tribunal (DRT)
Proceedings under the Code of Civil Procedure
Board for Industrial & Financial Reconstruction (BIFR)/ AAIFR
National Company Law Tribunal (NCLT)
Sale of NPA to other banks
Sale of NPA to ARC/ SC under Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest Act 2002 (SRFAESI)
The description of these points is as below
1. Restructuring and Rehabilitation
a. Banks are free to design and implement their own policies for restructuring/ rehabilitation
of the NPA accounts
b. Reschedulement of payment of interest and principal after considering the Debt service
coverage ratio, contribution of the promoter and availability of security
2. Corporate Debt Restructuring
a. The objective of CDR is to ensure a timely and transparent mechanism for restructuring of
the debts of viable corporate entities affected by internal and external factors, outside the
purview of BIFR, DRT or other legal proceedings
b. The legal basis for the mechanism is provided by the Inter-Creditor Agreement (ICA). All
participants in the CDR mechanism must enter the ICA with necessary enforcement and
penal clauses.

c. The scheme applies to accounts having multiple banking/ syndication/ consortium accounts
with outstanding exposure of Rs.10 crores and above.
d. The CDR system is applicable to standard and sub-standard accounts with potential cases
of NPAs getting a priority.
e. Packages given to borrowers are modified time & again
f. Drawback of CDR Reaching of consensus amongst the creditors delays the process
DRT Act
a. The banks and FIs can enforce their securities by initiating recovery proceeding under the
Recovery if Debts due to Banks and FI act, 1993 (DRT Act) by filing an application for
recovery of dues before the Debt Recovery Tribunal constituted under the Act.
b. On adjudication, a recovery certificate is issued and the sale is carried out by an auctioneer
or a receiver.
c. DRT has powers to grant injunctions against the disposal, transfer or creation of third party
interest by debtors in the properties charged to creditor and to pass attachment orders in
respect of charged properties
d. In case of non-realization of the decreed amount by way of sale of the charged properties,
the personal properties if the guarantors can also be attached and sold.
e. However, realization is usually time-consuming
f. Steps have been taken to create additional benches
3. Proceeding under Code of Civil Procedure
a. For claims below Rs.10 lacs, the banks and FIs can initiate proceedings under the Code of
Civil Procedure of 1908, as amended, in a Civil court.
b. The courts are empowered to pass injunction orders restraining the debtor through itself or
through its directors, representatives, etc from disposing of, parting with or dealing in any
manner with the subject property.
c. Courts are also empowered to pass attachment and sales orders for subject property before
judgment, in case necessary.

d. The sale of subject property is normally carried out by way of open public auction subject
to confirmation of the court.
e. The foreclosure proceedings, where the DRT Act is not applicable, can be initiated under
the Transfer of Property Act of 1882 by filing a mortgage suit where the procedure is same as
laid down under the CPC.
BIFR AND AAIFR
a. BIFR has been given the power to consider revival and rehabilitation of companies under
the Sick Industrial Companies (Special Provisions) Act of 1985 (SICA), which has been
repealed by passing of the Sick Industrial Companies (Special Provisions) Repeal Bill of
2001.
b. The board of Directors shall make a reference to BIFR within sixty days from the date of
finalization of the duly audited accounts for the financial year at the end of which the
company becomes sick
c. The company making reference to BIFR to prepare a scheme for its revival and
rehabilitation and submit the same to BIFR the procedure is same as laid down under the
CPC.
d. The shelter of BIFR misused by defaulting and dishonest borrowers
e. It is a time consuming process
4. SALE OF NPA TO OTHER BANKS
a. A NPA is eligible for sale to other banks only if it has remained a NPA for at least two
years in the books of the selling bank
b. The NPA must be held by the purchasing bank at least for a period of 15 months before it
is sold to other banks but not to bank, which originally sold the NPA.
c. The NPA may be classified as standard in the books of the purchasing bank for a period of
90 days from date of purchase and thereafter it would depend on the record of recovery with
reference to cash flows estimated while purchasing
d. The bank may purchase/ sell NPA only on without recourse basis

e. If the sale is conducted below the net book value, the short fall should be debited to P&L
account and if it is higher, the excess provision will be utilized to meet the loss on account of
sale of other NPA.
5. SARFESI Act 2002
a. SARFESI provides for enforcement of security interests in movable (tangible or intangible
assets including accounts receivable) and immovable property without the intervention of the
court
b. The bank and FI may call upon the borrower by way of a written legal notice to discharge
in full his liabilities within 60 days from the date of notice, failing which the bank would be
entitled to exercise all or any of the rights set out under the Act.
c. Another option available under the Act is to takeover the management of the secured assets
d. Any person aggrieved by the measures taken by the bank can proffer an appeal to DRT
within 45 days after depositing 75% of the amount claimed in the notice.
e. Chapter II of SARFESI provides for setting up of reconstruction and securitization
companies for acquisition of financial assets from its owner, whether by raising funds by
such company from qualified institutional buyers by issue of security receipts representing
undivided interest in such assets or otherwise.
f. The ARC can takeover the management of the business of the borrower, sale or lease of a
part or whole of the business of the borrower and rescheduling of payments, enforcement of
security interest, settlement of dues payable by the borrower or take possession of secured
assets
g. Additionally, ARCs can act as agents for recovering dues, as manager and receiver.
h. Drawback differentiation between first charge holders and the second charge holders
Second Amendment & SARFESI
a. The second amendment and SARFESI are a leap forward but requirement exists to make
the laws predictable, transparent and affordable enforcement by efficient mechanisms outside
of insolvency
b. No definite time frame has been provided for various stages during the liquidation
proceedings

c. Need is felt for more creative and commercial approach to corporate entities in financial
distress and attempts to revive rather than applying conservative approach of liquidation
d. Tribunals have largely failed to serve the purpose for which they were set up. NCLT would
be over-burdened with workload. Change in eligibility criteria for making a reference would
itself generate a greater workload.
e. The second amendment stops short of providing a comprehensive bankruptcy code to deal
with corporate bankruptcy.
f. Does not introduce the required roadmap of the bankruptcy proceeding viz:
Application for initiating
Appointments & empowerment of trustee
Operational and functional independence
Accountability to court
Monitoring and time bound restructuring
Mechanism to sell off
Number of time bound attempts for restructuring
Decision to pursue insolvency and winding up
Strategies for realization and distribution
g. Need for new laws & procedures to handle bankruptcy proceedings in consultation with
RBI
Perceived Impact
Adapting to Basel II will be more demanding for some institutions than for others, based on
factors including current risk management practices, business size, geographical spread, risk
types, specific business, portfolio, and market conditions


Impact on various entities in financial markets
Apart from banks and regulators, who are directly affected by Basel II, customers, rating
agencies, capital markets and other financial companies (outside the scope of Basel II) will
also be affected. Banks will have to implement an enterprise-wide risk management
framework, which will entail establishing relevant processes and gathering, integrating and
analysing large amount of data. Using quantitative methods to manage risk - and to deploy
capital based on risks - requires high quality and high frequency data.
Customers will find that they have to cope with increased demands for timely information
from banks that are on IRB approaches. Risk-based pricing of credit products will become
the norm as banks begin differentiating customers as per their risk profiles. Riskier borrowers
are likely to find their borrowing costs going up and/or credit lines tightened up. Rating
agencies may face more competition as themarket for them will expand and deepen, which
will be a driver for them to be more transparent in their rating process. Good quality rated
corporates will prefer capital markets to banks for their funding. Securitisation and credit
derivatives will increasingly be used as credit risk hedging tools.
Basel II is also likely to impact financial institutions that do not have to comply with it. Non-
banking corporations such as credit card companies, leasing companies, auto manufacturers
and financiers, or retailers financing arms may not have to fulfill the potentially extensive
disclosure requirements prescribed by Basel II nor make investments in managing operational
risk, which will put them at a competitive advantage vis--vis banks.
Impact on emerging markets and smaller banks

In an attempt to assess the impact of Pillar 1 requirements of capital adequacy, BCBS did
undertake a few quantitative impact surveys (QIS), the last of which is referred to as QIS- 3.
The results indicated that, in general, banks required capital will decrease with respect to
credit risks and increase with respect to operational risks. However, in Asia and other
emerging markets, several factors may raise the required capital even for credit risks, as real
estate continues to be widely used as collateral for business loans, and the standardised
approach, which is the most likely approach for many banks, places a 150 per cent risk
weight on non-performing loans. Basel II will increase the level of capital that is required for
banking institutions in the emerging markets, mainly owing to the new operational risk
charge, which will be higher if the basic indicator approach is used. By application of
differential risk weights on the basis of sovereign rating as a benchmark, the capital inflows
in emerging markets could be seriously affected as most of the borrowers in such markets
will be categorised under the speculative grade. Smaller banks would find the investments on
Basel II compliance too big for their existing budgets.
Implications for India
The official position of the Reserve Bank of India (RBI), as emphasized in its response to
CP3 of BCBS, is as follows, Ìn its (Basel II) attempt to strive for more accurate measure of
risks in banks, the simplicity of the present Capital Accord is proposed to be replaced, with a
highly complex methodology which needs the support of highly sophisticated MIS / data
processing capabilities. The complexity and sophistication essential for banks for
implementing the new capital accord restricts its universal application in the emerging
markets. RBI had also suggested that a common definition of ìnternationally active banks
be provided by BCBS. Even the United States of America is not adopting the new accord for
all of its banks. But, in the same response, RBI has also affirmed that it is `fully committed to
implement the best international practices.


The response from the Indian banking industry is equally positive. Ìndian Banks are not
averse to making the investment of the effort to embrace global practices, asserts V.
Leeladhar, chairman, Indian Banks Association (IBA) and chairman and managing director,
Union Bank of India. H.N. Sinor, chief executive officer, IBA, adds `Basel II is a reality that
no progressive country can afford to ignore. It provides an opportunity for global integration
and ushering in international best practices. Viewed against these brave words from the
major Indian banks, the Indian regulator RBI, appears to be more cautious and pragmatic,
holding a view that `Banks in emerging markets would, therefore, face serious
implementation challenges due to lack of adequate technical skills, under development of
financial markets, structural rigidities and less robust legal systems. Besides banks,
supervisors would be required to invest considerable resources in upgrading technology
systems, and human resources to meet the minimum standards. Having successfully
implemented the 1988 Basel Accord, the Indian banking industry is poised to implement the
1996 Amendment for inclusion of market risk in capital adequacy calculations this year.
Sinor expects Indian banks to eventually embrace Basel II, albeit slowly and without making
noises. Supporting the phased approach taken by RBI with respect to Basel II, Sinor feels
that `the new accord provides incentives to banks for improving their credit portfolio through
risk management. Leeladhar expresses confidence that ìn any event, banks will reap the
benefits of improved systems and efficiency in the long term.
Initially, banks in India will have to adopt the standardised approach (possibly the simplified
one) for credit risk, and the basic indicator approach for operational risk calculations. RBI
had done a selective impact study last year using these approaches on data sourced from
seven major banks. The results of both the RBI study and the QIS-3, suggest an increase of
one to two per cent on account of credit risk and eleven per cent on account of operational
risk, in the minimum capital requirements, moving from Basel I to Basel II. Kapoor provides
the roadmap, saying `Most (Indian) banks are likely to start with simpler, elementary
approaches, just adequate to ensure compliance to Basel II norms and gradually adopt more
sophisticated approaches. The continued regulatory challenge will be to migrate to Basel II in
a non-disruptive manner. Competitive compulsions will ensure that banks make the necessary
investments in the appropriate technology and qualified, experience professionals to adopt
advanced approaches. `The new accord will reward those banks that use a more
sophisticated IRB approach to measure and manage risk. Counters Niall S.K. Booker, chief
executive officer, HSBC India and chairman of the IBA Committee on Basel II, `There is the
possibility that in international markets access may be easier and costs less for banks
adopting a more sophisticated approach.however in a market like India it seems likely that
the large domestic players will continue to play a very significant role regardless of the model
used. Meanwhile, Leeladhar is hopeful that banks will ultimately adopt the IRB approach for
credit risk.
The additional capital charge on account of operational risk is considered `harsh by bankers
and software suppliers unanimously. But all of them agree that it will benefit banks in the
long term by making them sensitive to operational risk. Sinor hopes that the operational risk
charge will eventually be calibrated down as the implementation progresses.

It is generally agreed the implementation of Basel II is likely to provide momentum for
mergers and acquisitions in the Indian banking industry. Shenoy thinks that `The higher
disclosure requirements in the banking sector might lead to a growing tendency towards
structural changes in the form of mergers and acquisitions. Kapoor provides another reason,
saying às more and more banks move towards the advanced approaches, the gap between the
strong and weak banks will increase further, making the weaker banks potential takeover
targets
Here are a few excerpts, which describe RBIs current approach:
`We are now not debating whether to go forward with BaselII but how to implement Basel
II. In fact, understanding Basel II concepts is one step away from agreeing to it in principle.
Implementing Basel II is another long step away from understanding it.
`RBIs approach to the institution of prudential norms has been one of gradual convergence
with international standards and best practices with suitable country specific adaptations. Our
aim has been to reach global best standards in a deliberately phased manner through a
consultative process evolved within the country. RBI had in April 2003 itself accepted in
principle to adopt the new capital accord.
`RBI has announced, in its Annual Policy statement in May 2004 that banks in India should
examine in depth the options available under Basel II and draw a road-map by end December
2004 for migration to Basel II and review the progress made thereof at quarterly intervals.
Àt a minimum all banks in India, to begin with, will adopt Standardized Approach for
credit risk and Basic Indicator Approach for operational risk. After adequate skills are
developed, both in banks and at supervisory levels, some banks may be allowed to migrate to
IRB Approach.
Ìndia has three established rating agencies in which leading international credit rating
agencies are stakeholders. However, the level of rating penetration is not very significant as,
so far, ratings are restricted to issues and not issuers. Encouraging ratings of issuers would be
a challenge.
`Basel II could actually imply that the minimum requirements could become procyclical.
No doubt prudent risk management policies and Pillars II and III would help in overall
stability. We feel that it would be preferable to have consistent prudential norms in good and
bad times rather than calibrate prudential norms to counter pro-cyclicality.


`Banks adopting IRB Approach will be much more risk sensitive than the banks on
Standardised Approach, (so) the banks on Standardised Approach could be inclined to
assume exposures to high risk clients, which were not financed by IRB banks. Due to
concentration of higher risks, Standardised Approach banks can become vulnerable at times
of economic downturns.
`Keeping in view the cost of compliance for both banks and supervisors, the regulatory
challenge would be to migrate to Basel II in a non-disruptive manner. We would like to
continue the process of interaction with other countries to learn from their experiences.
Criticism of Basel 2 accord
Before we set out to list the concerns that have been voiced against Basel II, we must
acknowledge the fact that any attempt to regulate the complexity that current global financial
infrastructure presents is far from easy. Trying to model such complexity involves what we
would prefer to call `modeling risk, which can be reduced by backtesting the model, but not
eliminated entirely. Under this section only general arguments against Basel II have been
discussed. The rest appears in the perceived impact section where Basel II prescriptions have
different implications for different markets and entities.
Pro-cyclicality
In simple terms, pro-cyclicality means that banks governed by Basel II (capital tied to risks)
will loosen credit in `good times (when risk perceptions are low) and restrict it when times
are bad (when risks rise again). If most banks act in this fashion, having adopted the accord,
they would accentuate the crisis in bad times, jeopardizing stability. Risk-based financial
regulation is inherently pro-cyclic. The pro-cyclicality springs from the treatment of risk as
an exogenous variable, whereas in reality, it is endogenous. The actions of a market
participant based on a predictive model affects the market and if many participants are using
the same model, their combined actions render the basic assumptions of the model on the
heterogeneous nature of the market (normal distribution)

false. `Requiring banks to run their capital through a stress test to assess what impact
worsening economic conditions will have on their loan portfolios, and requiring bank
supervisors to evaluate those models independently, increases the safety of the bank. This is
one of the measures that will help the banks to be less pro-cyclical because they will have
taken into account the whole (business) cycle,
Fearsome complexity
The US Comptroller of Currency, John D. Hawke Jr., considers CP3 (Consultative Paper 3)
published by Basel Committee as having `mind-numbing complexity. `Can anyone
reasonably assume that a mandate of the complexity of Basel II will be applied with equal
forcefulness across such a broad spectrum of supervisory regimes, asks Hawke.
The meek answer from BCBS is that the complexity of the new accord results from the
complexity it seeks to address. `This (Basel II implementation) is a task of extreme
complexity involving the intersection of computer science, mathematics and finance,
says Dr. Ron Dembo, founding chairman of Algorithmics Inc., a Toronto- based company
specializing in financial risk management software.
Heavy Implementation Costs
Data monitor estimates that financial institutions worldwide will spend close to US$ 4 billion
over two years on upgrading databases and other systems in order to comply with Basel II.
Aberdeen Group estimates that banks will spend US $3.2 billion in the next four years
preparing for Basel II. Àsian banks are expected to spend between seven to ten per cent of
their global IT and business operations budget on Basel II compliance for the next four to six
years, observes BIS.
While such estimates would be music to the ears of software suppliers and consulting firms,
the moot question for banks are `what benefits will accrue from this investment? and `how
long will the pay back period be?
Credit Risk Concerns
Using the standardized approach, un-rated corporate borrowers attract less risk weight (100
per cent) than the lowest rated borrower (150 per cent) giving incentives to high-risk
borrowers to remain un-rated. Another argument against Basel II is that it does not resort to
full credit risk modelingit fails to take into account portfolio effects of risk mitigation
through diversification.


Concerns of National Supervisors
The New Accord is criticized on the ground of being as much prescriptive as to be lacking in
trust for national supervisors. Also, Pillar 2 requires national supervisors to give up arms-
length supervision in favour of participative implementation. Supervisors also need to invest
heavily in people and technology to perform their duties as envisaged in Basel II.


Chapter - 6
Recommendations


Suggestion
After all these points, I just want to say that NPA is a big problem of banks. Due to this crisis
the NPA are also increased. Thats why all the banks are facing problems. So banks have to
take care of those banks.
My recommendations are:
1. Strengthening provision norms and loan classification standards based on forward looking
criteria (like future cash flows) were implemented.
2. Through securitization they can reduce NPA
3. Speed of action- the speedy containment of systematic risk and the domestic credit crunch
problem with the injection of large public fund for bank recapitalization are critical steps
towards normalizing the financial system.
4. Strengthening legal system
5. Maintain required capital adequacy ratio as per basel 2 norms. That means now the
provision for NPL will be more. This may look a conservative approach. But it should be
implemented to reduce risk.
6. Modification in accounting system
7. Use the concept of credit derivative
8. Aligning of prudential norms with international standard.


BIBLIOGRAPHY
BOOKS REFERRED:
MISHRA and PURI, Economic Environment of Business, Delhi, Himalaya
Publishing House,2000edition.
C R KOTHARI, RESEARCH METHODOLOGY, Bangalore, Vishwa
Prakashan Publishing House .

JOURNALS REFERRED:
ICFAI JOURNAL Banking & Regulation Laws , Hyderabad, Reserve Bank
of India Act 1934 Pg.no 45- 72
WEBSITES VISITED:
Marketresearch.com
South Indian Bank.com
Google.com
RBI.com
Businessstandard.com


ANNEXURE
SOUTH INDIAN BANK
Year Mar 08 Mar 07 Mar 06 Mar 05 Mar 04
SOURCES OF FUNDS :
Capital + 90.41 70.41 70.41 47.68 35.78
Reserves Total + 1,070.58 653.55 570.44 407.58 359.11
Deposits + 15,156.12 12,239.21 9,578.66 8,492.31 8,280.03
Borrowings + 27.58 32.51 0.72 3.72 79.45
Other Liabilities & Provisions + 745.24 656.90 607.19 526.22 499.68
TOTAL LIABILITIES 17,089.93 13,652.58 10,827.42 9,477.51 9,254.05
APPLICATION OF FUNDS :
Cash & Balances with RBI+ 973.65 699.67 546.08 433.16 404.62
Balances with Banks & money at Call+ 729.00 1,245.81 797.39 268.06 401.46
Investments + 4,572.23 3,430.13 2,739.39 3,133.43 3,962.09
Advances + 10,453.75 7,918.91 6,370.23 5,365.26 4,196.82
Fixed Assets + 112.75 89.59 89.80 77.60 65.83
Other Assets + 248.55 268.47 284.53 200.00 223.23
Miscellaneous Expenditure not written off 0.00 0.00 0.00 0.00 0.00
TOTAL ASSETS 17,089.93 13,652.58 10,827.42 9,477.51 9,254.05
Contingent Liability+ 2,105.35 1,640.58 1,295.19 997.24 801.91
Bills for collection 181.85 168.15 183.05 111.07 123.75

HDFC BANK

SOURCES OF FUNDS :
Capital + 354.43 319.39 313.14 309.88 284.79
Reserves Total + 11,142.80 6,113.76 4,986.39 4,209.97 2,407.09
Deposits + 100,768.60
6
8,297.94
55,796.82 36,354.25 30,408.86
Borrowings + 4,478.86 2,815.39 2,858.48 4,790.01 2,307.82
Other Liabilities & Provisions + 16,506.32 13,772.81 9,632.04 5,841.87 6,971.42
Cash & Balances with RBI+ 12,553.18 5,075.25 3,306.61 2,650.13 2,541.98
Balances with Banks & money at Call+ 2,225.16 3,971.40 3,612.39 1,823.87 1,008.90
Investments + 49,393.54 30,564.80 28,393.96 19,349.81 19,363.46
Advances + 63,426.90 46,944.78 35,061.26 25,566.30 17,744.51
Fixed Assets + 1,175.13 966.67 855.08 708.32 616.91
Other Assets + 4,477.10 3,796.39 2,357.57 1,407.55 1,104.22
TOTAL ASSETS 133,251.01 91,319.29 73,586.87 51,505.98 42,379.98
Contingent Liability+ 593,008.08 328,148.24 214,782.34 140,777.15 82,116.17
Bills for collection 6,920.71 4,606.83 2,828.89 2,549.68 2,097.89

AXIS BANK
SOURCES OF FUNDS :
Capital + 357.71 281.63 278.69 273.80 231.58
Reserves Total + 8,410.79 3,111.60 2,593.49 2,134.39 904.84
Deposits + 87,626.22 58,785.60 40,113.53 31,712.00 20,953.90
Borrowings + 5,624.04 5,195.60 2,680.93 1,781.41 527.75
Other Liabilities & Provisions + 7,606.90 5,935.28 4,117.99 1,898.16 1,532.10
Cash & Balances with RBI+ 7,305.66 4,661.03 2,429.40 3,448.74 3,776.93
Balances with Banks & money at Call+ 5,198.58 2,257.28 1,212.44 1,054.20 1,886.27
Investments + 33,705.10 26,897.16 21,527.35 15,048.02 7,792.76
Advances + 59,661.14 36,876.48 22,314.23 15,602.92 9,362.95
Fixed Assets + 922.85 673.19 567.71 518.44 435.16
Other Assets + 2,832.33 1,944.57 1,733.50 2,127.44 896.10
TOTAL ASSETS 109,625.66 73,309.71 49,784.63 37,799.76 24,150.17
Contingent Liability+ 258,895.60 184,164.75 98,565.38 53,185.74 37,439.67
Bills for collection 8,323.39 6,274.63 4,332.20 3,616.98 1,915.81


Analysis of NPA Management

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Analysis of NPA Management

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