An assignment ON

NON-PERFORMING ASSETS (NPA)

Faculty of Management Studies Banaras Hindu University

of Management of Financial Institutions and services in partial fulfillment of the requirement for two year full time Masters Programme in MBA

Submitted to Prof Raj Kumar Faculty of Management Studies Banaras Hindu Universdity Vsaranasi

Submitted by Abhishek Bhushan

MBA - III Sem. 2011-12 Roll No.-55 Enrollment no.:295656 Examination Roll No. 07M51001

Non Performing Asset

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.

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

In 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.

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.

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 'Loan 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 and 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.,

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 semiurban 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 NonPerforming Assets into Now-Performing Assets. It's now or never.