INTRODUCTION

BANKING IN INDIA

A bank is a financial institution that provides banking and other financial services. By
the term bank is generally understood an institution that holds a Banking Licenses.
Banking licenses are granted by financial supervision authorities and provide rights to
conduct the most fundamental banking services such as accepting deposits and
making assets. There are also financial institutions that provide certain banking
services without meeting the legal definition of a bank, a so-called Non-bank. Banks
are a subset of the financial services industry. The word bank is derived from the
Italian banca, which is derived from German and means bench. The terms bankrupt
and "broke" are similarly derived from banca rotta, which refers to an out of business
bank, having its bench physically broken. Moneylenders in Northern Italy originally
did business in open areas, or big open rooms, with each lender working from his own
bench or table. Typically, a bank generates profits from transaction fees on financial
services or the interest spread on resources it holds in trust for clients while paying
them interest on the asset. Development of banking industry in India followed below
stated steps.

Banking in India has its origin as early as the Vedic period. It is believed that the
transition from money lending to banking must have occurred even before Manu, the
great Hindu Jurist, who has devoted a section of his work to deposits and advances
and laid down rules relating to rates of interest.

Banking in India has an early origin where the indigenous bankers played a very
important role in lending money and financing foreign trade and commerce. During
the days of the East India Company, was the turn of the agency houses to carry on the
banking business. The General Bank of India was first Joint Stock Bank to be
established in the year 1786. The others which followed were the Bank Hindustan and
the Bengal Bank.

In the first half of the 19th century the East India Company established three banks;
the Bank of Bengal in 1809, the Bank of Bombay in 1840 and the Bank of Madras in
1843. These three banks also known as Presidency banks were amalgamated in 1920
and a new bank, the Imperial Bank of India was established in 1921. With the passing
of the State Bank of India Act in 1955 the undertaking of the Imperial Bank of India
was taken by the newly constituted State Bank of India.

The Reserve Bank of India which is the Central Bank was created in 1935 by passing
Reserve Bank of India Act, 1934 which was followed up with the Banking
Regulations in 1949. These acts bestowed Reserve Bank of India (RBI) with wide
ranging powers for licensing, supervision and control of banks. Considering the
proliferation of weak banks, RBI compulsorily merged many of them with stronger
banks in 1969.

The three decades after nationalization saw a phenomenal expansion in the

geographical coverage and financial spread of the banking system in the country. As
certain rigidities and weaknesses were found to have developed in the system, during
the late eighties the Government of India felt that these had to be addressed to enable
the financial system to play its role in ushering in a more efficient and competitive
economy. Accordingly, a high-level committee was set up on 14 August 1991 to
examine all aspects relating to the structure, organization, functions and procedures of
the financial system. Based on the recommendations of the Committee (Chairman:
Shri M. Narasimham), a comprehensive reform of the banking system was introduced
in 1992-93. The objective of the reform measures was to ensure that the balance
sheets of banks reflected their actual financial health. One of the important measures
related to income recognition, asset classification and provisioning by banks, on the
basis of objective criteria was laid down by the Reserve Bank. The introduction of
capital adequacy norms in line with international standards has been another
important measure of the reforms process.

1. Comprises balance of expired assets, compensation and other bonds such as

National Rural Development Bonds and Capital Investment Bonds. Annuity
certificates are excluded.
2. These represent mainly non- negotiable non- interest bearing securities issued
to International Financial Institutions like International Monetary Fund,
International Bank for Reconstruction and Development and Asian
Development Bank.
 3. At book value.

4. Comprises accruals Under small Saving Scheme, Provident Fund ,Special Deposits
of Non government.

In the post-nationalization era, no new private sector banks were allowed to be set up.
However, in 1993, in recognition of the need to introduce greater competition which
could lead to higher productivity and efficiency of the banking system, new private
sector banks were allowed to be set up in the Indian banking system. These new banks
had to satisfy among others, the following minimum requirements:

I. It should be registered as a public limited company;

II. The minimum paid-up capital should be Rs 100 crore;
III. The shares should be listed on the stock exchange;
IV. The headquarters of the bank should be preferably located in a centre
which does not have the headquarters of any other bank; and
V. The bank will be subject to prudential norms in respect of banking
operations, accounting and other policies as laid down by the RBI. It will
have to achieve capital adequacy of eight per cent from the very
beginning.

A high level Committee, under the Chairmanship of Shri M. Narasimham, was

constituted by the Government of India in December 1997 to review the record of
implementation of financial system reforms recommended by the CFS in 1991 and
chart the reforms necessary in the years ahead to make the banking system stronger
and better equipped to compete effectively in international economic environment.
The Committee has submitted its report to the Government in April 1998. Some of the
recommendations of the Committee, on prudential accounting norms, particularly in
the areas of Capital Adequacy Ratio, Classification of Government guaranteed
advances, provisioning requirements on standard advances and more disclosures in
the Balance Sheets of banks have been accepted and implemented. The other
recommendations are under consideration.

The banking industry in India is in a midst of transformation, thanks to the economic

liberalization of the country, which has changed business environment in the country.
During the pre-liberalization period, the industry was merely focusing on deposit
mobilization and branch expansion. But with liberalization, it found many of its
 advances under the non-performing assets (NPA) list. More importantly, the sector
has Become very competitive with the entry of many foreign and private sector banks.
The face of banking is changing rapidly. There is no doubt that banking sector
reforms have improved the profitability, productivity and efficiency of banks, but in
the days ahead banks will have to prepare themselves to face new challenges.

An introduction to NPA in Indian banking system

The accumulation of huge non-performing asset in bank has assumed great

importance. The depth of the problem of bad debts in Indian banking system was first
realized only in early 1900s. So, question arise what is an NPA? You may note that
for a bank, the loan given by the bank is considered as its assets. So if the principle or
the interest or both the components of a loan is not being serviced to the lender
(bank), then it would be considered as non-performing assets (NPA). Any assets
which stop giving returns to its investor for a specified period of time is known as
non-performing assets.

Reserve Bank of India (RBI) defines NPAs as “An asset, including a leased asset,
become non-performing when it ceases to generate income for the bank”. A ‘non-
performing asset’ (NPA) was defined as a credit facility in respect of which the
interest and/ or instalment of principle has remained ‘past due’ for a specified period
of time. The specified period was reduced in a phased manner as under:

Year ending March 31 Specified period

1993 Four quarters

1994 Three quarters
1995 onwards Two quarters

Classification of Banking Structure in India

This scheduled banks are divided into scheduled commercial banks and schedule

co-operative banks. Further scheduled commercial banks can be into the public sectors

banks , private sector banks, foreign banks , and regional banks. Where as scheduled

co-operative banks are classified into scheduled urban co-operative and scheduled state

co-operative. RBI has further classified public sector banks into schedule nationalized
banks, State Banks of India and its subsidiaries. And private banks have

been classified into old and new private sector banks. As far as the number is

concerned, total public sector banks are 27 [total 27 PSBs in India-21 nationalized

banks + 6 State Bank group (SBI+5 Association) and rest two are IDBI Bank and

Bharatiya mahila Bank, which are categorized as other public sector banks.],

private sector banks are 30, foreign banks are 36, and regional rural banks are 196.

Thus in scheduled commercial banks, the regional rural are on the top number. In the

scheduled co-operative banks, there are 57 scheduled co-operative and 16 scheduled

co-operative banks. Today the overall commercial banking system in India may be

distinguished into:

1. Public Sector Banks

2. Private Sector Banks

3. Co-operative Sector Banks

4. Development Banks

PUBLIC SECTOR BANKS

a. State Bank of India and its associate banks called the State Bank group

b. 20 nationalised banks

c. Regional Rural Banks mainly sponsored by Public Sector Banks

PRIVATE SECTOR BANKS

a. Old generation private banks

b. New generation private banks

c. Foreign banks in India

d. Scheduled Co-operative Banks

e. Non-scheduled Banks

CO-OPERATIVE SECTOR

The co-operative banking sector has been developed in the country to the supplement

the village money lender. The co-operative banking sector in India is divided into 8

components
1. State Co-operative Banks

2. Central Co-operative Banks

3. Primary Agriculture Credit Societies

4. Land Development Banks

5. Urban Co-operative Banks

6. Primary Agricultural Development Banks

7. Primary Land Development Banks

8. State Land Development Banks

DEVELOPMENT BANKS

1. Industrial Finance Corporation of India (IFCI)

2. Industrial Development Bank of India (IDBI)

3. Industrial Credit and Investment Corporation of India (ICICI)

4. Industrial Investment Bank of India (IIBI)

5. Small Industries Development Bank of India (SIDBI)

6. National Bank for Agriculture and Rural Development (NABARD)

7. Export Import Bank of India

8. National Housing Bank

Factors for rise in NPA

The banking sector has been facing the serious problem of the NPA. But the problem

of NPA is more in public sector banks when compared to private sector banks and

foreign banks. The NPA in PSB are growing due to external as well as internal

factors.

A) External factors

1) Ineffective recovery tribunal

The Govt. has set of numbers of recovery tribunals, which works for recovery of loans

and advances, due to their carelessness and ineffectiveness in their work the bank

suffers the consequence of non-recover, thereby reducing their profitability and

liquidity.
2) Will-ful default

There are borrowers who are competent to pay back loans but are intentionally

withdrawing it. These groups of people should be recognized and proper measures

should be taken in order to get back the money extended to them as advances and

loans.

3). Natural calamities

This is the measure factor, which is creating alarming increase 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 pay damages those loans, hence end up the fiscal with a reduced profit.

Basically ours farmers depends on rain fall for cropping. Due to irregularities of rain

fall the farmers are not to attain the production level thus they are not repaying the

loans.

4). Industrial sickness

Inappropriate project handling , ineffective management , lack of adequate resources ,

lack of advance technology , day to day changing govt. Policies produce industrial

sickness. Therefore the banks that finance those industries ultimately end up with a

low recovery of their loans reducing their profit and liquidity.

5). Lack of demand

Entrepreneurs in India could not predict 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 smallest label. Therefore the banks record the

non-recovered part as NPAs and has to make provision for it.

6) Change on Govt. policies

With every new govt. banking sector gets new policies for its operation, so it has to

cope with the changing principles and policies for the regulation of the rising of

NPAs.

For example, 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 government to renew the handloom

sector has not yet been implemented, so the over dues due to the handloom sectors are

becoming NPAs.

B) Internal Factors

1) Defective Lending process

There are three cardinal principles of bank lending that have been followed by the

commercial banks, that is, Principles of safety, Principle of liquidity, Principles of

profitability. Principles of safety mean that the borrower is in a position to pay back

the loan, including both principal and interest. The refund of loan depends upon the

borrowers, Capacity to pay and Willingness to pay.

Capacity to pay depends upon, Tangible assets, Success in business. Willingness to

pay depends on, Character, Honest, Reputation of borrower. The banker should,

therefore take utmost care in ensuring that the enterprise or business for which a loan

is sought is a sound one and the borrower is competent of carrying it out successfully,

he should be a person of integrity and good character.

2) Inappropriate technology

Due to improper technology and management information system, market driven

decisions on real time basis cannot be taken. Proper MIS and financial accounting

system is not implemented in the banks, which leads to poor credit collection, so

NPA, therefore all the branches of the bank should be computerized.

3) Improper SWOT analysis

The inappropriate strength, weakness, opportunity and threat analysis is another

reason for increase in NPAs. While providing unsecured advances the banks depend

more on the honesty, integrity, and financial soundness and credit worthiness of the

borrower, so, banks should consider the borrowers own capital investment and bank

should collect credit information of the borrowers from, a. Bankers b. Enquiry from

market/segment of trade, industry, business c. From external credit rating agencies.

Banker should examine the balance sheet which shows the true picture of business
will be revealed on analysis of profit/loss a/c and balance sheet. When bankers give

loan, he should examine the purpose of the loan. To make sure safety and liquidity,

banks should grant loan for productive purpose only. Bank should examine the

profitability, viability, long term acceptability of the project while financing.

4) Poor credit appraisal system

Deprived credit appraisal is an additional factor for the increase in NPAs, due to poor

credit appraisal the bank gives advances to those who are not able to repay it back.

They should use better credit appraisal to reduce the NPAs.

5) Managerial deficiencies

The banker should always select the borrower very cautiously and should take

tangible assets as security to safe guard its interests. When accepting securities, banks

should consider the Marketability, Acceptability, Safety, Transferability etc. The

banker should follow the principle of diversification of risk based on the famous

maxim “do not keep all the eggs in one basket”, which 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 latest big customer meets misfortune or certain traders or

industries affected adversely, the overall position of the bank will not be affected.

6) 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. So the NPAs can be collected by regular visits.

The growth and proliferation in the activities of the bank has led to ever-increasing

non-performing assets that have mounted to a huge amount during the last decade or

so. The quantum of NPAs has been calculated and put at different figures mainly due

to absence of correct statistics and the method on the basis adopted for calculating the

percentage of NPAs in relation to either the total assets of the bank or the quantity of

loan portfolio or on the basis of the number of the accounts or the size of the

outstanding advances.
For a large number of years, the banks have been taking credit in its books, on basis

of accrued interest income, even for the sum of periodic interest that was not really

paid by the borrower. This was done by raising debit in suspense account and

crediting amount equivalent to the periodic interest in the loan account of the

borrower.

After objections from the auditors and income tax authority the banks altered strategy

and started giving extra loans to the defaulting borrowers for the purpose of making

payments to the bank for adjustment of the over dues, in many cases the due dates of

payments were postponed and even the entire period of the loan was extended further

again and again. As if to attach fire to the fuel, ambitious programme for branch

progress and extension of banking services led to new recruitments, transfers,

relocation and unhealthy competition amongst offices of the same bank, but at the

same time adequate facilities available for training of the staff were not expanded.

In the anxiety to attain business targets the rules and procedures for prudent banking

were conveniently forgotten. Even the senior management setup conveniently relaxed

the rules for proper appraisal of the loan proposals, the provisions of standard bank

sanction letter, errors in execution of the loan agreements, deeds of hypothecation and

mortgages were more often overlooked for compliance in the hurry for disbursement

and attainment of targets for purposes of building up record of achievements and

reporting.

7) 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 of the defaulters NPA is increasing day by day