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.

The paper deals with understanding the concept of NPAs, its magnitude and major causes for an
account becoming non-performing, projection of NPAs over next three years in Public sector banks and
concluding remarks.

CAUSES FOR NON-PERFORMING ASSETS IN PUBLIC SECTOR BANKS

Introduction

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 a 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. The severity of the problem is however
acutely suffered by Nationalised Banks, followed by the SBI group, and the all India Financial Institutions.
Objectives of the study

i. To understand the meaning & nature of NPAs.

ii. To examine the causes for NPAs in public sector banks.
iii. To project the NPAs in public sector banks over next three years using Trend Analysis as a tool.

Methodology

In order to meet the Third objective, the method of Moving Averages is been used, from which we arrive
at a Trend Analysis. While the rationale behind selection of 'Three year Moving Average' method is
because of the availability of the data. The data available was from the ten years and needless to say
that for such a data a 'Six year Moving average' or a 'Eight year Moving Average' will not work out.

Meaning of NPAs

An asset is classified as Non-performing Asset (NPA) if due in the form of principal and interest are not
paid by the borrower for a period of 180 days. However with effect from March 2004, default status
would be given to a borrower if dues are not paid for 90 days. If any advance or credit facilities granted
by banks to a borrower becomes non-performing, then the bank will have to treat all the
advances/credit facilities granted to that borrower as non-performing without having any regard to the
fact that there may still exist certain advances / credit facilities having performing status.

Though the term NPA connotes a financial asset of a commercial bank, which has stopped earning an
expected reasonable return, it is also a reflection of the productivity of the unit, firm, concern, industry
and nation where that asset is idling. Viewed with this perspective, the NPA is a result of an
environment that prevents it from performing up to expected levels.

The definition of NPAs in Indian context is certainly more liberal with two quarters norm being applied
for classification of such assets. The RBI is moving over to one-quarter norm from 2004 onwards.

Magnitude of NPAs

Inn India, the NPAs that are considered to be at higher levels than those in other countries have of late,
attracted the attention of public. The Indian banking system had acquired a large quantum of NPAs,
which can be termed as legacy NPAs.

NPAs seem to be growing in public sector banks over the years.

The following are the figures of gross and net NPAs of public sector banks from the period 1993 – 2002

(Table – 1)
NPAs in Public Sector Banks
End March
Gross NPAs
%of Gross Advances
% to Total Assets
Net NPAs
% of Net Advances
% of Total Assets

1993
39,253
23.2
11.8
18,077
11.3
4.6

1994
41,041
24.8
10.8
18,903
12.87
5.1

1995
38,385
19.5
8.7
17,567
10.7
4.0

1996
41,661
18.0
8.2
18,297
8.9
3.6
1997
43,577
17.8
7.8
20,285
9.2
3.6

1998
45,653
16.0
7.0
21,232
8.2
3.3

1999
58,554
15.6
6.8
24,211
8.85
3.1

2000
59,952
14.0
6.6
26,188
7.97
3.0

2001
68,238
13.1
6.4
28,032
6.8
2.6

2002
81,889
12.8
6.0
29,874
6.1
2.2

A distinction is often made between Gross NPA and Net NPA. Net NPA is obtained by deducting items
like interest due but not recovered, part payment received and kept in suspense account etc., from
Gross NPA.

As shown in the above table –1 over the years the NPAs as a percentage of net advances and total assets
have been declining but actual numbers are increasing.

Dealing with NPAs involves two sets of policies

1. Relating to existing NPAs

2. To reduce fresh NPA generation.

As far as old NPAs are concerned, a bank can remove it on its own or sell the assets to AMCs to clean up
its balance sheet. For preventing fresh NPAs, the bank itself should adopt proper policies.

Causes for Non Performing Assets

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.

One of the main causes of NPAs into banking sector is the directed loans system under which
commercial banks are required a prescribed percentage of their credit (40%) to priority sectors. As of
today nearly 7 percent of Gross NPAs are locked up in 'hard-core' doubtful and loss assets, accumulated
over the years.

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 amount 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 repayment of several of the
loans were poor, the quality of these assets were steadily deteriorating. Credit allocation became 'Lon
Melas', loan proposal evaluations were slack and as a result repayment were very poor.

There are several reasons for an account becoming NPA.

* Internal factors
* External factors

Internal factors:

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, mis-appropriation etc.,
9. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups, delay in
settlement of payments\ subsidiaries by government bodies etc.,

External factors:

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.,

Gross NPAs sector wise as on March 2001

(Table 2)

Borrowing segment wise distribution of NPAs

Amount Rs. in crores
Percentage of Total NPAs

Public Sector Units

1334.05
2.4

Large industries
11498.7
20.99

Medium Industries
8658.69
15.81

Other non-priority sectors

9516.62
17.37

Agriculture
7311.4
13.34

Small Scale Industries

10284.98
18.78
Other Priority Sectors
6169.3
11.72

(Source: RBI website)

Conclusion Regarding Contributory Reasons

The study of about 900 top NPA accounts in 27 public sector banks that has been tabulated from the
available information revealed by RBI, that the following are the important factors for units becoming
sick/weak and constantly accounts turning NPA in the order of prominence:

* Diversification of funds (No. 7 above – Internal factor), mostly for expansion \diversification \
modernization, taking up of new projects, is the single most prominent reason. Besides being so, this
factor also has significant proportion of cases, when compared to other factors.

* Internal factor (No. 6 above), failure of business (product), inefficient management, inappropriate
technology, product obsolescence.

* External factor (No. 3 above), comprising industrial recession, price escalation, power shortage,
accidents etc.,

* Time \ cost overrun during the project implementation stage leading to liquidity strain and turning
NPA into next factor (No. 2 above – Internal factor).

* Other factors in order or prominence are Government Policies like changes in Import \ Excise duties
etc., (No 5 above – External factor), willful default, fraud \ misappropriation, disputes etc., (No. 8 above
– Internal factor) and lastly, deficiencies on the part of banks delays in release of limits and delay in
settlement of payments by government bodies (No. 6 above – External factor).

(Exhibit – 1)

Causes for an Account becoming NPA

Those Attributable
to Borrower
Causes Attributable
to Banks
Other Causes
a) Failure to bring in Required capital
b) Too ambitious project
c) Longer gestation period
d) Unwanted Expenses
e) Over trading
f) Imbalances of inventories
g) Lack of proper planning
h) Dependence on single customers
i) Lack of expertise
j) Improper working Capital Mgmt.
k) Mis management
l) Diversion of Funds
m) Poor Quality Management
n) Heavy borrowings
o) Poor Credit Collection
p) Lack of Quality Control
a) Wrong selection of borrower
b) Poor Credit appraisal
c) Unhelpful in supervision
d) Tough stand on issues
e) Too inflexible attitude
f) Systems overloaded
g) Non inspection of Units
h) Lack of motivation
i) Delay in sanction
j) Lack of trained staff
k) Lack of delegation of work
l) Sudden credit squeeze by banks
m) Lack of commitment to recovery
n) Lack of technical, personnel & zeal to
a) Lack of Infrastructure
b) Fast changing technology
c) Un helpful attitude of Government
d) Changes in consumer preferences
e) Increase in material cost
f) Government policies
g) Credit policies
h) Taxation laws
i) Civil commotion
j) Political hostility
k) Sluggish legal system
l) Changes related to Banking amendment Act

Projection of NPAs over next three years in public sector Banks

The paper focuses on projecting the Non Performing Assets of Public Sector Banks over next three years.
The method used for this study is "Trend Analysis – Three year Moving Average Method."

The study focused on measuring the Trend for four aspects:

1. Gross NPAs to Gross Advances

2. Gross NPAs to Total Advances
3. Net NPAs to Net Advances
4. Net NPAs to Total Advances

The formula used for "Three year Moving Average" is:

A+b+c , b+c+d , c+d+e , d+e+f , …….
3333

This is one of the flexible methods of measuring the trend. While applying this method, it is necessary to
select a period for moving average appropriately depending upon the availability of the data. In this case
the data available was ten years and hence the Three-year moving average found to be suitable for
projecting the future trend.

Assumptions

While measuring the future trend of NPAs for next three years in public sector banks, the following are
the key issues, which are assumed to be constant.

* It is to be noted that the norms for recognizing NPAs are changing every year. Previously it was four
quarters, then it was made to three quarters and now from come 2004 it will be only one quarter.

* For commercial Banks the Capital Adequacy Norms are been prescribed recently, which were not
mentioned in the early 90's.

* Norms regarding Provisions have changed over the last decade.

* Income Recognition norms were introduced in mid 90's.

* According to Basel committee Prudential Norms were introduced.

* Asset Liability Management Guidelines is expected to be issued by RBI.

1. Gross NPAs to Gross Advances:
(Table-3)

Year
Gross NPAs / Gross Advances
Trend Line

1. 1992-93
23.2
-

2. 1993-94
24.8
22.5

3. 1994-95
19.5
20.8

4. 1995-96
18.0
18.43

5. 1996-97
17.8
17.26

6. 1997-98
16.0
16.56

7. 1998-99
15.9
15.33

8. 1999-00
14.0
14.1
9. 2000-01
12.4
12.5

10. 2001-02
11.1
-

(Graph 1)

Note: Series – 1: Gross NPAs to Gross Advances

Series – 2: Trend Line

Analysis

During the year 1992-93 to 2001-02, there has been a sharp decline in Gross NPAs to Gross Advances.
The Trend Line also shows a continues decreasing trend. From this, it can be concluded that over the
next three years (i.e 2002-03 to 2004-05), Gross NPAs to Gross Advances of public sector banks would
decrease.

2. Gross NPAs to Total Advances:

(Table – 4)

Year
Gross NPAs / Total Advances
Trend Line

1. 1992-93
11.8
-

2. 1993-94
10.8
10.43

3. 1994-95
8.7
9.23
4. 1995-96
8.2
8.23

5. 1996-97
7.8
7.66

6. 1997-98
7.0
7.16

7. 1998-99
6.7
6.56

8. 1999-00
6.0
6.00

9. 2000-01
5.3
5.4

10. 2001-02
4.9
-

(Chart 2)

Note: Series – 1: Gross NPAs to Total Advances

Series – 2: Trend Line

Analysis

During the year 1992-93 to 2001-02 , there has been considerable decline in GNPAs to Total Assets. The
Trend Line too says the same story. Therefore the GNPAs to Total Assets of public sector banks will
decline in the next three years to come (i.e 2002-03 to 2004-05).
3. Net NPAs to Net Advances:
(Table – 5)

Year
Net NPAs / Net Advances
Trend Line

1. 1992-93
11.3
-

2. 1993-94
12.87
11.62

3. 1994-95
10.7
10.82

4. 1995-96
8.9
9.6

5. 1996-97
9.2
8.76

6. 1997-98
8.2
8.5

7. 1998-99
8.1
7.9

8. 1999-00
7.4
7.4

9. 2000-01
6.7
6.63

10. 2001-02
5.8
-

(Chart 3)

Note: Series - 1: Net NPAs to Net Advances

Series – 2: Trend Line

Analysis

During the year 1992-93 to 2001-02, there has been a steady and considerable decrease in percentage
of Net NPAs to Net Advances. The Trend Line also shows that there is a decreasing trend and Net NPAs
over next three years (i.e 2002-03 to 2004-05) would decrease considerably.

4. Net NPAs to Total Assets:

(Table – 6)

Year
Net NPAs / Total Assets
Trend Line

1. 1992-93
4.6
-

2. 1993-94
5.1
4.56

3. 1994-95
4
4.23

4. 1995-96
3.6
3.76

5. 1996-97
3.7
3.53

6. 1997-98
3.3
3.36

7. 1998-99
3.1
3.1

8. 1999-00
2.9
2.9

9. 2000-01
2.7
2.66

10. 2001-02
2.4
-

(Chart 4)

Note: Series -1: Net NPAs to Total Assets

Series – 2: Trend Line

Analysis

During the year 1992-93 to 2001-02, there has been a marginal decline in Net NPAs to Total Assets. The
Trend Line shows that there has been a steady decline and it can be inferred that over next three years
(i.e 2002-03 to 2004-05), Net NPAs to Total Assets of public sector banks would decrease but at a
marginal rate.
Final Analysis

The future picture of Commercial banks more so the public sector banks seem to be rosy. As the Trend
Line suggests that the NPAs of public sector banks will decline marginally both in terms of Gross and Net
figures over next three years. This may be due to higher provisions, which the public sector banks have
been providing. The real issue to be identified is though the NPAs, as a percentage seems to be declining
over the years but the absolute figures seems to be increasing. In this vein it would be interesting to see
the NPAs both in terms of absolute figures and in terms of percentage of public sector banks in the
coming three years.

Concluding Remarks

A strong banking sector is important for a flourishing economy. The failure of the banking sector may
have an adverse impact on other sectors.

Over the years, much has been talked about NPAs and the emphasis so far has been only on
identification and quantification of NPAs rather than on ways to reduce and upgrade them.

There is also a general perception that the prescription of 40% of net bank credit to priority sectors have
led to higher NPAs, due to credit to these sectors becoming sticky. Managers of rural and semi-urban
branches generally sanction these loans. In the changed context of new prudential norms and emphasis
on quality lending and profitability, managers should make it amply clear to potential borrowers that
banks resources are scarce and these are meant to finance viable ventures so that these are repaid on
time and relevant to other needy borrowers for improving the economic lot of maximum number of
households. Hence, selection of right borrowers, viable economic activity, adequate finance and timely
disbursement, correct end use of funds and timely recovery of loans is absolutely necessary pre
conditions for preventing or minimizing the incidence of new NPAs.

However, banks are yet another sector where the rot has already set in!..

It is high time to take stringent measures to curb NPAs and see to it that the

Non-Performing Assets may not turn banks into Non-Performing Banks; instead steps should be taken to
covert Non-Performing Assets into Now-Performing Assets.

It's now or never