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Banks: No more NPA laundering

Apr 15, 2005

Window dressing their books of accounts, by temporarily hiving off the bad loan accounts, was a rampant norm with most smaller banks having a sizeable NPA legacy. The bad loans were taken in the books of the purchasing bank as standard assets and once again transferred to the original bank at a later date. The cosmetic transfer thus enabled banks to re-route the loss assets to their books as 'fresh loans'. This method of laundering the loss assets will now be a thing of the past. Reserve Bank of India (RBI), in its draft guidelines on purchase/sale of NPAs has clearly outlined its concerns about prudence in maintaining asset quality. The guidelines have also been formulated with a view to develop a healthy secondary market for non-performing assets where securitisation companies and reconstruction companies are not involved.

Key highlights of the guidelines:

Procedure for purchase/sale of NPAs

  • A non-performing asset (NPA) in the books of a bank shall be eligible for sale to other banks only if it has remained a non-performing asset for at least two years in the books of the selling bank.

  • A bank may purchase/sell non-performing financial assets from/to other banks only on 'without recourse' basis, i.e., the entire credit risk associated with the non-performing financial assets should be transferred to the purchasing bank.

  • Banks shall sell non-performing financial assets to other banks only on cash basis.

  • A non-performing asset should be held by the purchasing bank in its books, at least for a period of 15 months before it is sold.

Asset classification norms
The non-performing financial asset may be classified as 'standard' in the books of the purchasing bank for a period of 90 days from the date of purchase. Thereafter, the asset classification status of the account shall be determined by the record of recovery in the books of the purchasing bank with reference to cash flows estimated while purchasing the asset.

However, the asset classification status of an existing exposure to the same obligor in the books of the purchasing bank will continue to be governed by the record of recovery of that exposure and hence may be different. For eg. If Bank A has a loan account of Mr. M (which is a good asset) and it acquires the same Mr. M's NPA loan account from Bank B, it cannot club the two accounts and has to treat them separately as per their respective records of recovery.

Provisioning norms

Books of selling bank

  • When a bank sells its non-performing financial assets to other banks, the same will be removed from its books on transfer.

  • If the sale is at a price below the net book value (NBV) (i.e., book value less provisions held), the shortfall should be debited to the profit and loss account of that year.

  • If the sale is for a value higher than the NBV, the excess provision shall not be reversed but will be utilised to meet the shortfall/loss on account of sale of other non-performing financial assets.

Books of purchasing bankThe asset shall attract provisioning requirement appropriate to its asset classification status in the books of the purchasing bank.

Any recovery in respect of a NPA purchased from other banks should first be adjusted against its acquisition cost. Recoveries in excess of the acquisition cost can be recognised as profit.

Risk weightage
For the purpose of capital adequacy, banks should assign 100% risk weights to the NPAs purchased from other banks. In case the non-performing asset purchased is an investment, then it would attract capital charge for market risks also.

What does this mean?
In the wake of higher credit outgo, it is pertinent for banks to exercise diligence in terms of assessing and disclosing their asset quality. Also, with a spate of public issues envisaged in the sector in the current financial year, strict guidelines from the apex bank in this respect augurs well for investor's estimation of the true 'value' of their proposed investment. Consolidation and the impending Basel accord also call for prudence not just from the larger entities but also from their smaller counterparts. No wonder the RBI is leaving no stone unturned to revive the sector's fortunes.

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