• Are mounting NPA’s a sign of poor credit risk management ?
• What are the costs of an NPA on the books of the bank? • How is a loan priced? DEFINITION “ We should not forget that the basic economic function of these regulated entities is to take risk. If we minimise risk taking in order to reduce failure rates to zero, by definition, have eliminated the purpose of the banking system” – Alan Greenspan, President, Federal Reserve Board, U.S.A. INTERPRETATION • Banks have to take risk but risk has to be managed in a professional way. • To manage risk one has to understand different types of risk and how to mitigate them. • The risk is same for corporate and retail credit but the degree varies and is measured differently • Credit risk denotes defaults Non Performing Accounts • Standard Accounts • Substandard Accounts - where the delinquency is 12 months or less • Doubtful Accounts – where the delinquency exceeds 12 months or value of security falls below 50% Secured Category I - doubtful for 1 year Secured Category 2 – doubtful for 1 to 3 years Secured Category 3- doubtful for more than 3 years Unsecured – unsecured portion of a doubtful asset • Loss Assets - where security value is negligible ( generally less than 10% of the outstanding loan amount Provisioning norms
• Substandard – 10% + additional 10% on the unsecured portion
• Doubtful -1 – 20% on secured portion & 100% on unsecured • Doubtful 2 - 30% on secured portion & 100% on unsecured • Doubtful 3 – 100% • Loss asset – 100% GENUINE DEFAULTS • When a borrower fails to repay the loan instalments due to personal set backs like loss of job, personal inability or huge medical expenses, etc, such borrower is classified as genuine defaulter. • The borrower has real intention to repay the loan in time. • Intention to pay is intact but ability to pay is affected. • The approach of recovery is one of care and concern and customer oriented. WILFUL DEFAULTS • A borrower who deliberately fails to pay the loan instalments even though he has sufficient cash flows to pay is called a wilful defaulter. • The intention of the borrower in malafide. • The reason is to delay and he has no willingness to pay. • The bank’s approach is firm and prompt. • Bank should act swiftly the moment the sign of wilful default is known. • A wilful default is considered a fraud on the Bank RECOVERY PROCESS • In the case of genuine defaulters, recovery process is gentle and professional so that the genuine borrowers respond favourably. • In the case of wilful defaulters, banks have to take prompt recovery steps with out delay as persuasive method is bound to fail. • Banks have to bring out recovery policy every year to identify thrust areas and more focus should be given to those portfolios where defaults are high. RECOVERY PROCESS • Meeting defaulters helps banks to find out the reason for default. • If it is for genuine reasons, banks can take pro active steps like re- phasing or restructuring the existing loans to prevent them from becoming NPAs. • If defaulters are wilful defaulters, banks can take recovery steps like repossession and securitization of assets charged to the banks. RECOVERY PROCESS • Recovery is a constant attempt to recover loans on due dates. • This requires constant monitoring and follow up. • RBI has put in place concept of special monitoring account to prevent performing assets slipping in to non performing assets. • So the early alert system helps banks to take prompt recovery steps by meeting defaulters. Special Mention Accounts • Three categories of accounts-
SMA 0 – repayments due from 1 to 30 days + additional criteria of triggers to EWS
SMA 1 - repayments due from 31 to 60 days SMA 2 - repayments due from 61 to 90 days
The SMAs are recognised inorder to
• Arrest further slippage • Initiate prompt corrective actions Further SMA classification is required as per RBI guidelines Steps to be taken When accounts are classified as SMA the bank should take the following steps
Discuss the problem with the Promoter
Obtain the latest financial statements Conduct verification of all collaterals ( ensure that the securities are intact) The bank can also discuss rescheduling of the account, handholding in genuine cases RESCHEDULEMENT • Banks are permitted to re-phase or reschedule loans before they become NPA. • This rephasement or rescheduling can be done for genuine defaulters. • Bank has to find out from the borrowers the reason for reduced cash flow to confirm whether such reduced cash flow is temporary or permanent. • At times banks are permitted to reschedule substandard assets and in specific cases retain them in the same category RESCHEDULEMENT • Increase in floating interest or reset in fixed interest rates may change the equated monthly instalments.This is also one of the reasons for default on loan instalments by retail borrowers. • Under these circumstances banks can re-phase the loan instalments by lengthening the period of repayment by keeping the existing EMI intact. • Banks also resort to stepping up the EMI to match the increase in future cash flows like annual increase in salary. Early warning signals These are generally signals that warrant close monitoring of the accounts by the bank. The EWS can be identified in these areas Financial Operational Physical Attitudinal changes The list is not exhaustive
Current ratio dropping to 80 % of benchmark
Leverage ratio increasing significantly No operations in account for more than 30 days Borrower reporting stress in the unit Delay in submission of statements Deteriorating financial statements and operating losses for more than 2 quarters RECOVERY PROCESS • There are many recovery tools available to bankers. Through recovery agents, recovery through Lok Adalats, action under SARFAESI ACT 2002 or DRT to name a few. Banks can also take legal steps like filing suits in the civil courts for relief if they are not able to take action under SARFAESI. • Repossession of security is aimed at recovery of dues. • Repossession is possible for movable assets charged to banks and this is possible only after issuing notice to defaulters on repossession. • Due process of law should be followed. RECOVERY PROCESS • Once the securities are repossessed with the help of authorized recovery agents, banks have to take prompt action in selling them in public auction. • Even after repossession but before auction sale, defaulter can take back the movable security after clearing the dues and charges incurred on repossession. RECOVERY AGENTS • RBI has given detail guide lines on appointment and role of recovery agents in commercial banks as an aftermath of supreme court judgement. • As per RBI guidelines on appointment of recovery agents, they should be properly trained to handle with care and sensitivity of the issue, their responsibilities and the legal procedures of recovery. • Banks should have adopt due diligence process for hiring recovery agents. RECOVERY AGENTS • IBA is directed by the RBI to train recovery agents for period of minimum 100 hours on nuances of recovery process. • Banks are directed to shortlist trained recovery agents. • There is uniformity in training of recovery agents and certificates are given to the trained recovery agents issued by Indian Institute of Banking and Finance (IIBF). • Banks should inform the defaulters the names and other details of the recovery agents hired for recovery of repossession of charged securities. • Recovery agents are directed to video graph the recovery action taken by them to prevent borrowers prefer false criminal complaints of using force or adopting third degree methods of recovery. SARFAESI ACT • SARFAESI Act, passed in the year 2002 came as boon to banks as the act has given quasi judicial powers to authorized officers of banks to seize secured movable and immovable assets charged to the banks. • This act has helped banks to recover their dues without seeking legal remedy in the civil courts which took very long time for recovery of bank dues. • Besides the recovery is cumbersome through legal process. SARFAESI ACT • Under the provisions of this act, recovery is possible within 120 days as the defaulters are given 60 day notice to repay the entire loan outstanding plus interest and cost. If they fail to repay, the banks are empowered to take physical or symbolic possession of securitized assets. Thereafter sale notice is issued to the defaulters and finally sale by auction is done. • 45 days time limit is given between taking symbolic or physical possession of securitized assets and auction sale of the asset. This time limit is given for borrowers to arrange funds to pay loan arrears and get the sale proceeding dropped or take legal course by moving debt recovery tribunals to stay auction sale on the grounds of merit. SARFAESI ACT • Once the securitized asset is sold in public auction and sale proceeds are to be used to clear the existing loan in full and cost incurred on recovery process. • Balance if any should be credited to the account of the borrowers with intimation to them. • SARFAESI Act has helped banks to recover major chunk of defaulted secured loans thereby increase the comfort level of banks to further lend for retail asset products. RECOVERY THROUGH LOK ADALATS • Under the directions of supreme court of India, RBI has directed banks to utilize the services offered by district court judges for recovery of bank dues through conciliation process. • This is possible only when suits are pending in civil courts and there is willingness on both the parties to the litigation for conciliation and settlement. RECOVERY THROUGH LOK ADALATS • The district judge or any serving judge will be the presiding officer of Lok Adalat. • He hears both sides and gives his award based on the merit of the case. • Once his award is acceptable to both the parties, the suits filed in civil courts are withdrawn. • The defaulters have to pay as committed before the Lok Adalat and clear his/her loan liabilities. DEBT RECOVERY TRIBUNALS • DRTs are created for speedy recovery of bank loans of Rs 20 lakhs and above. • Since SARFAESI Act is not applicable to agriculture loans and exempted category of loans, DRTs are utilized by banks to recover their dues. DRTs are expected to deliver judgements within 6 months from the date of filing the suit by banks. DEBT RECOVERY TRIBUNALS • DRTs have to hear the issues from both litigants and decide on the issue. • The judgement given by DRTs is in the form of recovery certificate. • Subsequently on getting recovery certificate, banks have to file it before recovery officer who is attached to DRTs for attachment and sale of assets charged to banks. • The procedure for recovery is not only cumbersome but also time consuming. SECURITISATION • Securitisation is the process of converting and breaking definable asset classes into tradable units and selling to others through a mechanism called as special purpose vehicle (SPV). • Through the securitisation process, the assets are removed from the balance sheet and funds generated through securitisation can be used for asset expansion. • Securitisation is the process of pooling of individual long term loans which are packaged and sold to various investors in the form of pass through certificates. • The advantage of securitisation is that the receivables are removed from the books as they have sold and the transaction does not create a liability in the balance sheet. SPV CONCEPT • The SPV converts assets into securities called “pass through certificates” and sell them to the buyers who may buy it for investment purpose. • Since these certificates are backed by assets, they are called asset backed securities (ABS). • If assets which have underlying mortgages are securitised , they are called as “mortgage based securitisation”. PROCESS • Securitisation helps in asset liability management SECURITISATION PROCESS: • The lender first selects the assets they want to securitize. • The issuer (SPV) makes payment to the lender for the loans securitised. • The assets are converted into pool of securities by the issuer for the purpose of issuing pass through certificates. PROCESS • The pass through certificates are sold to the investors who are willing to invest. • The lender continues to receive recoveries from the original borrowers and passed on to the SPV. • The SPV in turn passes the recoveries to the investors. PROCESS COLLATERAL DEBT OBLIGATION: • In the retail product , another concept called Collateral Debt Obligation (CDO) is also in vogue. • In CDO, asset classes/ receivables like car loans, credit card receivables and mortgage loans like home loan are grouped and securitised. • Multi layers of PTC with varying rates and coupons are issued based on the quality of assets and risk perceptions of the underlying assets. SECURITISATION OF RETAIL BANKING • The asset based securitisation which is backed by retail loans other than housing loans formed a major chunk of total asset based securitisation. • The mortgage based securitisation is applicable for all types of housing loans and mortgage based retail loans. • In the present scenario, banks resort to securitisation of retail assets to take advantage of increase in the interest rates on retail asset portfolio