INTRODUCTION: The banking industry has undergone a sea change after the first phase of economic liberalization in 1991 and hence credit management. While the primary function of banks is to lend funds as loans to various sectors such as agriculture, industry, personal loans, housing loans etc., in recent times the banks have become very cautious in extending loans. The reason being mounting non-performing assets (NPAs). An NPA is defined as a loan asset, which has ceased to generate any income for a bank whether in the form of interest or principal repayment. As per the prudential norms suggested by the Reserve Bank of India (RBI), a bank cannot book interest on an NPA on accrual basis. In other words, such interests can be booked only when it has been actually received. Therefore, an NPA account not only reduces profitability of banks by provisioning in the profit and loss account, but their carrying cost is also increased which results in excess & avoidable management attention. Apart from this, a high level of NPA also puts strain on a banks net worth because banks are under pressure to maintain a desired level of Capital Adequacy and in the absence of comfortable profit level, banks eventually look towards their internal financial strength to fulfill the norms thereby slowly eroding the net worth.
When a borrower, who is under a liability to pay to secured creditors, makes any default in repayment of secured debt or any installment thereof, the account of borrower is classified as nonperforming assets (NPA) .NPAs cannot be used for any productive purposes because they reflect the application of scarce capital and credit funds. Continued growth in NPA threatens the repayment capacity of the banks and erodes the confidence reposed by them in the banks. In fact high level of NPAs has an adverse impact on the financial strength of the banks who in the present era of globalization, are required to conform to stringent International Standards. “Non Performing Asset” means an asset or account of a borrower, which has been classified by bank or financial institution as substandard, doubtful or loan asset. After nationalization and globalization the initial directive that banks were given was to expand N.R.
INSTITUTE OF BUSINESS MANAGEMENT their branch network, increase the saving rate and extent credits to rural, urban and the most important SSI sectors. No doubt this mandate has been achieved admirably under the regulation of economic reforms initiated in 1991 by the then Finance Minister and present Prime minister Dr. Manmohan Singh. No doubt it would have been incomplete without the overhaul of Indian Banking System. Then all of a sudden focus shifted towards improving quality of assets and better risk management. The Narasimhan committee reports (First report) recommendations are the basis for initiation of the process, which is still continuing. The committee has recommended the enactment of a new legislation for securitization and empowering banks and financial institution to take possession of the securities and do sell them without the intervention of the court. The Narasimham Committee Report is without doubt a major path- breaking piece of work and deserves the support of all who yearn for a more rational and effective banking system in this country. In order to have the proper understanding of NPA menace, it is important to have a brief idea of growth and structural changes that have taken place in the banking sector.
The growth of the banking system can be assessed in five phases:-
1) Preliminary Phase(series of birth and death of banks)
2) Business Phase(period between 1949- 19 69)
3) Branching Out Phase(period when commercial banks got nationalized)
4) Consolidated phase(weaknesses and defects were identified)
5) Reforms and Strengthening Phase(1991 to till date)
Indian Banking Industry Saddled with High NPAs:
Reasons The liberalization policies launched in 1991 opened the doors to the entrepreneurs to setup industries and business, which are largely financed by loans from the Indian banking systems. Business firms and companies fail to pay the principal amount as well as the interest amount (Bad Loan) . In the global economy prevailing today, the vulnerability of Indian businesses has increased. A culture change is crept in where repayment of bank loans is no longer assured. A constant follow up action and vigil are to be exercised by the operating staff. Diversion of funds and willful default has become more common. As per a study published in the RBI bulletin in July 1999, diversion of funds and willful default are found to be the major contributing factors for NPAs in public and private sector banks.
Today, the situation looks optimistic with the industry succeeding in overcoming the hurdles faced earlier. The timely restructuring and rehabilitation measures have helped to overcome setbacks and hiccups without seriously jeopardizing their future. The greater transparency and stricter corporate governance methods have significantly raise N.R. INSTITUTE OF BUSINESS MANAGEMENT the credibility of the corporate sector.
The attrition rate in corporate sector has come down. The challenges before the banks in India today are the raising NPAs in the retail sector, propelled by high consumerism and lowering of moral standards. Other Factors: The problem that India faces is not lack of prudential norms but the legal impediments and time consuming nature of asset disposal process , „postponement‟ of the problem in order to report high earnings and to some extent manipulation of by the debtor using political influence. Most of the banks in India are into this malpractices and fraudulent acts. In the process of earning high returns on their investment by the above stated method, the banks become bankrupt or penniless. A vicious effect of the slow legal process is that banks are shying away from risks by investing a greater than required proportion of their assets in the form of sovereign debt paper.
The worst part is that the NPA of a private enterprise is both financially and politically undesirable. Earlier bankruptcy Law favored borrowers and law courts were not reliable vehicles. But the circumstances have changed. Laws were passed allowing the creation of asset management companies, foreign equity participation in securitisation and asset backed securitization. Impact of NPAs on Banking Operations: The efficiency of a bank is not reflected only by the size of its balance sheet but also the level of return on its assets. The NPAs do not generate interest income for banks but at the same time banks are required to provide provisions for NPAs from their current profits. The NPAs have deliterious impact in the interest income on the bank, bank profitability because of the providing of the doubtful debts, return on investment of course.
NPAs also disturb the Capital Adequacy Ratio (CAV) and economic value addition (EVR) of the banks. It is due to above factors, the public sector banks are faced with bulging NPAs which results in lower income and higher provisioning for doubtful debts and it will make a dent in their profit margin. In this context of crippling effect on banks operation the slew asset quality is placed as one of the most important parameters in the measurement of banks performance under the Camel‟s supervisory rating system of RBI. Whether trading of NPA between Banks illegal or not: The word „trading‟ here means purchasing or selling of NPAs between banks. So assignment or trading falls under the guidelines of Banking Regulation Act (BRA) which makes it legal .
But the Gujarat High court has recently held that the buying and selling of non performing assets is illegal. The court has ruled that such an activity is not a part of “banking activity” as contemplated under the Banking Regulation Act, 1949. The court held N.R. INSTITUTE OF BUSINESS MANAGEMENT that “Interest transfer of NPAs by banks is illegal and not a part of banking activity under the BR Act. Trading in debts is a speculative form of transaction that is not permissible activity and thus, cannot be a part of the business of a banking system” The ruling had an impact of sending shockwaves through the backbone of Indian economy and came under the greater scrutiny in academic circles too. But the judgment is yet to stand the Supreme test of judiciary scrutiny as the aggrieved Banks and concerned regulatory bodies (RBI and Indian Bank Association) have challenged the decision before the Supreme Court. In the interim, the legality of loan purchases is under cloud till now.
I feel the recent pronouncement of the Gujarat High Court has misinterpreted the term „debt‟ from legal as well as accounting point of view. A loan item or the borrower is an asset of a bank and not a debt. Thus, de-facto the assignment of loan (good or bad) amounts to transfer of asset and not debt. Even RBI considers interest NPA assignment between banks to be a significant tool for resolving the issue of Non Performing Assets and in the interest of banking policy .The decision given by the Honorable Courts in the cases that have been cited below (footnote16) was in favor of “assignment of NPAs between banks. Measures to control NPAs menace a lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism.
It is necessary that the banking system is equipped with prudential norms to minimize if not completely avoid the problem of credit risk. Effective management of NPA rather than elimination is prudent. All these issues gave the passage of evolution of the Securitization and Reconstruction of Financial Assets and enforcement of Security Interest Act (SARFAESI), 2002. It is a unique piece of legislation which has far reaching consequences. Securitization in India is still in a nascent stage but has potential in areas like mortgage Backed securitization. This act has a overriding power over the other legislation. SARFAESI ACT was promulgated to regulate the financial assets and enforcement of security interest and for matters connected therewith or incidental thereto. The main purpose of this act is to enable the creditors take possession of the secured assets and to deal with them without the intervention of the court. No doubt this Act was challenged in various courts on ground that it was loaded heavily in favour of lenders, giving little chance to the borrowers to explain their views once recovery process is initiated under the legislation. The major problem with the Indian banking system is that they depend largely upon lending and investments. The banks in the developed countries do not depend upon this income whereas N.R. INSTITUTE OF BUSINESS MANAGEMENT 86 percent of income of Indian banks is accounted from interest and the rest of the income is fee based.
The banker can earn sufficient net margin by investing in safer securities though not at high rate of interest. It facilitates for limiting of high level of NPAs gradually. It is possible that average yield on loans and advances net default provisions and services costs do not exceed the average yield on safety securities because of the absence of risk and service cost. The corporate debt restructuring is also one of the methods suggested for the reduction of NPAs. Its objective is to ensure a timely and transparent mechanism for restructure of corporate debts of viable corporate entities affected by the contributing factors outside the purview of DRT and other legal proceedings for the benefit of concerned. The problem of non -performing loans created due to systematic banking crisis world over has become acute. Focused measures to help the banking system to realize its NPAs has resulted into the creation of specialized bodies called Asset Management Companies which in India have been named Asset Reconstruction Companies (ARC‟s).
The main objective of ARCs is to act as :
1) A agent for any bank or financial institution for the purpose of recovering their dues from the borrowers.
2) A manager of the borrowers‟ asset taken over by banks or financial institution.
3) The receiver of properties of any bank or financial institution.
4) There have been instances of banks extending credit to doubtful debtors (who deliberately default on debt) and getting kickbacks for the same.
Ineffective Legal mechanisms and inadequate internal control mechanisms have made this problem grow – quick action has to be taken on both counts so that both the defaulters and the authorizing officer are punished heavily. Without this, all the mechanisms suggested above may prove to be ineffective. Conclusion The contaminated portfolio is definitely a bane for any bank. It puts severe dent on the liquidity and profitability of the bank where it is out of proportion. It is needless to mention, that a lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. It is necessary that the banking system is to be equipped with prudential norms to minimize if not completely to avoid the problem of NPAs. The onus for containing the factors leading to NPAs rests with banks themselves. This will necessitates organizational restructuring, improvement in the managerial efficiency and skill up gradation for proper assessment of credit worthiness It is better to avoid NPAs at the nascent stage of credit consideration by putting in place of rigorous and appropriate credit appraisal mechanisms.