Indian banks (particularly nationalised banks) are struggling to come out of the ‘net’ of non-performing assets. The rising level of non-performing assets (NPAs) amounting to about Rs 600 bn has plagued the Indian banking system. Thus urgent cleaning up of bank balance sheet has become a crucial issue.

Banks are in the risk business. In the process of providing financial services, they assume various kinds of risks viz. credit risk, market risk, operational risk, interest risk, forex risk and country risk. Among these different types of risks, credit constitutes the most dominant asset in the balance sheet, accounting for about 60% of total assets. The credit risk is generally made up of transaction risk (default risk) and portfolio risk. The risk management is a complex function and requires specialized skills and expertise. As a result managing credit risk efficiently assumes greater significance.

What is called an NPA?
It is those assets for which interest is overdue for more than 180 days. In simple words, an asset (or a credit facility) becomes non-performing when it ceases to yield income. As a result, banks do not recognize interest income on these assets unless it is actually received. If interest amount is already credited on an accrual basis in the past years, it should be reversed in the current year’s account if such interest is still remaining uncollected.

Once an asset falls under the NPA category, banks are required by the Reserve Bank of India (RBI) to make provision for the uncollected interest on these assets. For the purpose they have to classify their assets based on the strength and on collateral securities into:

• Standard assets: This is not a non-performing asset. It does not carry more than normal risk attached to the business.
  
  

• Substandard assets: It is an asset, which has been classified as non-performing for a period of less than two years. In this case the current networth of the borrower or the current market value of the security is not enough to ensure recovery of the debt due to the bank. The classification of substandard assets should not be upgraded (to standard assets) merely as a result of rescheduling of the payments. (Rescheduling indicates change in payment schedule by the borrower or by the banker) There must be a satisfactory performance for two years after such rescheduling.
  
  

• Doubtful assets: It is an asset, which has remained non-performing for a period exceeding two years.
  
  

• Loss assets: It is an asset identified by the bank, auditors or by the RBI inspection as a loss asset. It is an asset for which no security is available or there is considerable erosion in the realizable value of the security. (If the realizable value of the security as assessed by bank, approved valuers or RBI is less than 10% of the outstanding, it is known as considerable erosion in the value of asset.) As a result even though there may be some salvage or recovery value, its continuance as bankable asset is not warranted.

After classifying assets into above categories, banks are required to make provision against these assets for the interest not collected by them. In terms of exact prudential regulations, the provisioning norms are as under:

Asset Classification	Provision requirements
Standard assets	0.25%
Substandard assets	10%
Doubtful assets	20% - 50% of the secured portion depending on the age of NPA, and 100% of the unsecured portion.
Loss assets	It may be either written off or fully provided by the bank.

The increasing levels of bad quality loans marred the prospects of nationalised banks in the past few years. As a result banks shifted their focus from the industrial segment to the corporate lending. This has curtailed the incremental NPAs to a certain extent. In FY01, gross NPAs of public sector banks (PSBs) increased by 3% compared to 9% jump in NPA levels of new private sector banks. The RBI has tightened the prudential norms regarding classifying assets as non-performing in line with the international standards. Accordingly, with effect from FY04, an asset will be classified as NPA if the interest is overdue for 90 days (instead of 180 days currently). These norms are likely to strengthen the balance sheet of banks, notwithstanding the fact that in the near term the higher provisions could trim the profit growth.

The norms are tightened even for financial institutions (FIs). They are worst affected by the NPA wave thanks to lending to the commodity and economy sensitive sectors, not to mention that loans to steel, chemicals and textile sector played a key role in dragging down performance of FIs. So far they have been enjoying the privilege of recognizing a loan as NPA only if principal is overdue for more than 365 days and interest is outstanding for over 180 days. With a view to bring greater transparency, the RBI has proposed to reduce the time limit to 180 days (for principal). On the one hand imposition of stricter norms could lead to a difficult time for FIs, permitting them an option of restructuring their loans could give them some leeway.

PSB’s betting on restructuring Gross NPAs (Rs bn) FY00 FY01 Change Public sector banks 517 533 3.1% Old private banks 38 40 5.3% New private banks 9 9 8.6% Foreign banks 24 26 10.9% Financial institutions 143 157 9.7% Total 731 766 4.8%

To facilitate the speedy recovery of NPAs, the RBI came up with the idea of a one-time settlement scheme for outstanding loans in FY01. PSB’s have recovered about Rs 8 bn from 200,000 accounts in the last fiscal. Although, the scheme was extended till June 30, 2001, the response was not very encouraging, partly due to the legal impediments. However, the scheme actually gave the bankers an opportunity to make contact with borrowers, which were earlier in touch with only legal advisors or accountants. Empowering banks to enforce their charge without intervention of court could result in expeditious recovery of bad debts in future.

Apart from this scheme, the government has designed major policy reforms in order to enhance the efficiency of the banking system. It has decided to set up 7 more debt recovery tribunals (DRTs) in addition to the existing 22 and 5 appellate tribunals. It has also proposed to bring in legislation for facilitating foreclosure and enforcement of securities in case of default. Repealment of SICA (Sick Industrial Companies Act) was another major step. The RBI has already asked banks to file criminal cases against borrowers who are willful defaulters. These initiatives are expected to aid banks to quickly recover their dues from the borrowers.

Although ratio of net NPAs to net advances have been declining in the past two years, it hardly offers any comfort. This is due to the fact that in absolute terms NPAs are still very high (Rs 766 bn). Therefore, it will be a challenge for banks to overcome this problem. For this, the internal control system and risk management system are required to be strengthened by banks. There should be a system for timely detection of NPAs. An important means for positioning appropriate risk management techniques is the MIS development, which requires building up of strong database and other information sets.

The growing NPAs are a source of worry for the Finance Minister too. Looking at the changing scenario in the world markets, the problem becomes more ironical because Indian banking at this juncture cannot afford to remain unresponsive to the global requirements.

However, the outlook for the current fiscal looks bleak. Industrial production has slowed down and the recent economic data point to a recession. Credit offtake is also lacklustre. It does seem, at this point, that NPA levels of banks would not come down significantly during the current year.