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MEANING AND EMERGENCE OF NON PERFORMING ASSET
‘All is flux, nothing stays still. Nothing endures but change’1 The description is very apt as far as Indian banking is concerned. The source of flux in banking includes competition, consolidation, information technology, product and geographical expansion and regulation. Fluctuations of interest rates, exchange rates and commodity prices combined with rational self interest of lenders, borrowers and authorities influence the forces of change which call for financial innovation to meet the existing and emerging problems. The banking system, which is the lifeline of any economy, has in our country not been able to effectively adjust to the changes and has not been in the best of health for quite some time. One of the major reasons cited for this state of health has been the persistence of Non Performing Advances (NPAs) in banks books.2 This has been discussed at several occasions by analyst and economist tracking the Indian banking sector, particularly, Public Sector Banks (PSBs). The increased and devastating effect of NPAs on the economy has made the problem of NPAs an issue of debate, and of national priority.3
Joseph F. Sinky Jr., Commercial Bank Financial management, Pretice Hall International Inc., US., 1998, Preface, p, XXVII
Management of Non– Performing Advances, T.V. Gopalakrishnan, 2004 Edition, Northern Book center
Management of Non– Performing Assets in Banks, Sugan C.jain, 2005 Edition, RSBA publishers, paper published by Dr. S.B. Kamashetty
6 Since the economy and the banking system are interdependent for their functioning and growth.5 These banks provide a meeting ground for the savers and investors among various indicators of financial stability. have always to be sound and stable and enjoy public confidence for the efficient and effective discharge of this vital intermediating function. Through mobilization of resources and their better allocation. has had an adverse impact on the banking system. Finance links the present and future economy. the fiscal exercise of the Government and the economy in general. A common perspective is that the problem of banks’ non-performing loans is ascribed to political. social. credit risk and efficiency in the allocation of resources to productive sectors. No. technological. This sector is the foundation of modern economic development and linchpin of development strategy. 2. e-ISSN 2247 – 7225 www. banks play an important role in the development process of underdeveloped countries.org last updated on 10/12/2011 2 .Banking industry is a major sector of the economy that has achieved renewed focus after financial sector reforms and the entry of private sector banks. legal and environmental issues. So banks which function as intermediaries are an important source of financial resources.ijept. It forms the core of the financial sector of an economy. banks’ non-performing loan assumes critical importance since it reflects on the asset quality.7 4 5 6 7 Supra Supra Supra International Journal of Economic Practices and Theories.4 They improve the allocation of resources by lending money to priority sector of the economy. a problem in one sector affects the other. 1. Vol. The presence of huge Non – performing Advances in Banks and their continued unmitigated increases in absolute terms. 2011 (October). economic.
but were not in the public domain until the early nineties.56.9 GENESIS AND HISTORICAL PERSPECTIVE Non-Performing Assets (NPAs) have been plaguing the Indian financial sector for a long time. The reduction of NPAs is necessary to improve profitability of the banks and comply with capital adequacy norms. In this connection banks must be aware of the problems and recovery legislations of NPAs Nonperforming assets means an dvance where payment of interest or repayment of instalments of principal or both remains for a period of more than 180 days. liquidity and equity. NPA is an important parameter in the analysis of financial performance of banks.8 The magnitude of NPAs have a direct impact on banks profitability as legally they 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 RBI guidelines.The Banks in India face the problems of swelling non- performing assets (NPAs) and the issue is becoming more and more unmanageable. It is true that banks have to restrict their lending operations to secured advances only with adequate collateral securities.com/problems-and-recovery-of-npa-at-branch-banks/ 10/12/2011 9 last updated on Supra 3 . Therefore the biggest ever challenge that the banking industry now faces is management of NPAs. The Indian Banking sector is facing a serious situation in view of the mounting NPAs which are the tune of Rs. a significant number of loan assets involving uncertainty with respect to ultimate 8 http://wimbledonmashow. By that time. The NPAs have direct impact on banks profitability.000 crores in March 2002. The NPAs of Indian Banks are relatively huge by international standard.
with various players operating in identified niches.collection had piled up. As such. as reflected in the growth of retail banking. banks would have to gear up for the challenges of managing growth and consequent risks in the SME sector financing.202/Arcil1/knowledge_centre/publications/papers/NPA_S1_EmergingChallenges. the financial markets are well-developed and segmented. One way of ensuring focus would be to free up capital – both financial and human – and make them available for sustaining the growth in assets and profitability. While the progress on this front is likely to continue. sustaining this growth in the coming years may require focus on the supply side – capacity building. In the recent past a large part of the banking sector’s growth has been on the back of financing consumption.10 The Indian banking sector has played a commendable role in fuelling and sustaining growth in the economy. creating concerns with the opinion-makers about the health of the Indian banking and financial sectors. A growth driver in this phase would involve financing the emerging Small & Medium Enterprises (SMEs) sector of the economy.Performing Assets 10 http://203.117. In advanced economies. Commercial banking is conducted in a highly risk-managed and mitigated ambience.115. NPAs reflect natural waste in any economy. catering to various user/risk segments. Farming out the banks’ Non. unlike its Indian counterparts who are often required to take unmitigated risks as a part of business policy.pdf last updated on 10/12/2011 11 Supra 4 . This constitutes an effective institutional mechanism for targeting risks to players with an appetite for such risks.11 Addressing this issue and putting in place a suitable risk mitigation mechanism is going to be a fairly daunting challenge.
A.15 ii. post-liberalizing era. PRE-LIBERALIZATION ERA: In the context of accretion to NPAs in the banking system. Industrial licensing: The scale of the economy in relation to international standards was compromised. which specialize in this segment of the financial sector. could be an option worth evaluating.12 The origination of NPAs in the Indian banking landscape can be broadly discussed in two stages:13 A. pre-liberalization era. and B. Down-swings in agricultural sectors triggered by monsoon vagaries. non-availability of private 12 13 14 15 16 Supra Supra Supra Supra Supra 5 . leading to high capital costs per unit of production. the contributory factors during this period were mainly the following:14 i.16 Sector-wise reservation: Reservation of major sectors for investment by the Government of India (GoI) in the public sector structure in post-independence days became a necessity owing to various reasons. in reality labour productivity. bringing about all-round economic and demand recessions. coupled with application of automation. This was often said to be offset by lower labour costs.(NPA) portfolio to asset-recovery companies. However. outweighed the benefit from lower labour costs in the Indian context. among others.
the DFIs in India played the role of Venture Capital (VC) funding without capturing the possible upside of the model. because of non-availability of a favourable legal 17 18 19 Supra Supra Supra 6 . However. banks were not in a position to price the risk premium. therefore. it was difficult for the banking system to appraise project viability with any degree of certainty during the loan pay-back period. Role of Developmental Financial Institutions (DFIs): The DFIs played a predominant role in the growth financing during the pre-liberalization era. Controlled interest rate: In the controlled interest rate regime.economic objectives) became commercially unviable in the absence of a proper growth plan when faced with burgeoning employee costs during their lifecycle.18 iv. 17 iii. This led to cross-subsidization across the risk profile of the loan assets. and improper quality and product pricing (price-quality matrix issues) despite subsidization by the GoI. down-stream integration of SMEs with these PSUs led them to a sticky situation with their bankers owing to a longer receivable cycle/non-realization of receivables. be compared only with VC funding. As a result. in the absence of a conducive legal system.capital.19 v. In a way. reservation in some of these sectors led to setting up of uneconomical facilities. This model became unsustainable as they started facing difficulties in raising funds. the banks were not in a position to realize value from these collaterals. Tariff protection: In the absence of a long-term tariff policy. Although additional collaterals were taken for risky loan assets. In later years many of these Public Sector Units (PSUs) (though they might have served their socio. The success of DFIs can. In addition.
much higher than the Hindu rate of average growth of 3. banks were to follow the Basel Capital Accord. POST-LIBERALIZING ERA: India’s macroeconomic policies were conservative until the early eighties. permitted changes in product. In fact. adopted a time-based provisioning method and averted a near crisis situation by not imposing a write-off of the entire loan asset impairment amount based on present value of realizable cash flow upon recognition of NPA. a growing fiscal deficit triggered a macroeconomic crisis in 1991.22 20 21 22 Supra Supra Supra 7 . coupled with various extraneous factors. the Indian economy registered an average growth rate of 5. with a cautious move.20 B. they are often discredited with the failures.5 percent per annum during the previous three decades. The central bank. Accompanied by some liberalization in the form of de-licensing of select industries.8 percent per annum (seventh five-year plan).environment.21 With the commencement of reform of the economy in 1991.mix within the overall capacity(broad-banding) and creeping relaxation of imports during mideighties.3 percent per annum (sixth fiveyear plan) and 5. the Reserve Bank of India (RBI) issued the first set of comprehensive guidelines for Income Recognition and Assets Classification (IRAC) in April 1992. Consequently. However. there was a miniindustrial boom in the early part of the seventh five-year plan (1985-88).
requiring focused attention. seriously raising concerns about the possibility of India heading for a crisis. Many banks set up taskforces. On the face of a liquidity crisis. many of these projects had to borrow at abnormally high rates of interest. The CDR 23 24 Supra Supra 8 . In the late-nineties.24 The net upshot was that by the mid-nineties the banking industry became riskaverse towards corporate lending activity. special asset management groups. etc. Many specialists and experts were. in order to tackle the NPA stock problem. which was also due to setting up of a selfhelp mechanism. during a declining interest rate regime. Many banks took a strong position in government securities. the banking sector generally adopted a ‘provide and hold’ strategy.23 However. and against the back-drop of hyped-up demand projections endorsed by several leading strategists. to deal with the situation in a focused manner by creating a type of bad bank within the bank. namely Corporate Debt Restructuring (CDR). by then. the banking sector registered a decent credit growth during the subsequent period. towards the end of the decade. As a result. the mistake was realized as those loan assets started showing signs of impairment. By that time the entire South-East Asian region was reeling under an economic crisis triggered by the high level of NPAs in the banking system. the banking sector was sitting on a sizeable capital gain. As such.With a stable political scenario during post-commencement of reforms. Propelled by the growth in the retail sector. net NPAs in the system declined significantly. under the aegis of the RBI. The volume of NPAs in the system reached a peak level. the Indian economy once again experienced a quick capacity build-up during the mid-nineties.
forum has done a commendable job during the period since inception in 2002 to restrict the flow of NPAs in the system.25 25 Supra 9 .
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