Capstone Project Report On the topic

A STUDY OF NON PERFORMING ASSETS IN INDIAN PRIVATE BANKING SECTOR

LOVELY PROFESIONAL UNIVERSITY

In Partial Fulfillment of the Requirements for the Award of Degree Of MASTER OF BUSINESS ADMINISTRATION

Group Code: QDO5

Submitted by:Navjot Singh (11012664) Rahul Kundliya (11001882) Pankaj Bisht (11005154) Sumit kumar (11001711)

1 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

ACKNOWLEDGEMENT

It is often said that journey of a thousand miles begins with the first, uncertain if we may add, step. My journey was not too different. It involved the help, support and contribution of several people. It is difficult to ascertain the starting point for such thanks giving, and yet one usually starts with the most significant contributor. In my case let us begin with the people who strictly confined themselves to behind the scenes before I move on to the persons who directly affected the course and scope of events. I would like to extend our sincerest gratitude to Ms. Sakshi Sharma for her unrelenting support and an uncanny habit of pointing out the flaws in the scheme of things at the most crucial juncture, hence causing several opportunities for learning. I do not think it would be just to end such thanks giving without thanking our respondents for co-operating with us. Finally I also extend my heartiest thanks to all my friends and well wishers for being with me and extending encouragement throughout the project.

2 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

CERTIFICATION/THESIS APPROVAL BY FACULTY ADVISOR TO WHOMSOEVER IT MAY CONCERN

This is to certify that the project report titled ________________________________________ carried out by Mr. ------------------------------------------------------------ (student name), S/o or D/O ------------------------------------------------------- (Fathers Name) has been accomplished under my guidance & supervision as a duly registered MBA student of the Lovely Professional University, Phagwara. This project is being submitted by him/her in the partial fulfillment of the requirements for the award of the Master of Business Administration from Lovely Professional University. His dissertation represents his original work and is worthy of consideration for the award of the degree of Master of Business Administration.

___________________________________ (Name & Signature of the Faculty Advisor) Date:

3 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

DECLARATION I, "________________________________ (student's name), hereby declare that the work presented herein is genuine work done originally by me and has not been published or submitted elsewhere for the requirement of a degree programme. Any literature, data or works done by others and cited within this dissertation has been given due acknowledgement and listed in the reference section.

_______________________ (Student's name & Signature)

_______________________ (Registration No.)

Date:__________________

4 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

DECLARATION I, "________________________________ (student's name), hereby declare that the work presented herein is genuine work done originally by me and has not been published or submitted elsewhere for the requirement of a degree programme. Any literature, data or works done by others and cited within this dissertation has been given due acknowledgement and listed in the reference section.

_______________________ (Student's name & Signature) _______________________ (Registration No.) Date:__________________

5 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

DECLARATION I, "________________________________(student's name), hereby declare that the work presented herein is genuine work done originally by me and has not been published or submitted elsewhere for the requirement of a degree programme. Any literature, data or works done by others and cited within this dissertation has been given due acknowledgement and listed in the reference section.

_________________ (Student's name & Signature)

_______________________ (Registration No.) Date:__________________

6 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

DECLARATION

I, "________________________________ (student's name), hereby declare that the work presented herein is genuine work done originally by me and has not been published or submitted elsewhere for the requirement of a degree programme. Any literature, data or works done by others and cited within this dissertation has been given due acknowledgement and listed in the reference section.

_______________________ (Student's name & Signature)

_______________________ (Registration No.)

Date:__________________

7 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

TABLE OF CONTENTS

S.NO 1.
CHAPTER 1

PARTICULARS

PAGE.NO

INTRODUTION 1.1 Introduction To Non Performing Assets 1.2 Types of Banks 1.3 Non Performing Assets 1.4 Beneficiaries of the study

11-15

2.

Chapter 2 Review of Literature

16-19

3.

Chapter 3 Research Design & Methodology

20-23

4.

Chapter 4 Data Analysis and Interpretation Reasons for an account becoming NPAs Impact of NPAs on bank performance Consequences of NPAs Measures to Control NPAs

24-41

42-49

8 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

5.

Chapter 6 Suggestions & Conclusion

50-52

6.

Chapter 7 Bibliography

53-54 55-60

7.

Appendix

9 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

10 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

A STUDY OF NON PERFORMING ASSETS IN INDIAN PRIVATE BANKING SECTOR

Introduction
Banking sector reforms in India has progressed promptly on aspects like interest rate deregulation, reduction in statutory reserve requirements, prudential norms for interest rates, asset classification, income recognition and provisioning. But it could not match the pace with which it was expected to. The accomplishment of these norms at the execution stages without restructuring the banking sector as such is creating havoc, this research paper deals with the problem of having non-performing assets, the reasons for mounting of non-performing assets and the practices present in other countries for dealing with non-performing assets. During pre-nationalization period and after independence, the banking sector remained in private hands Large industries who had their control in the management of the banks were utilizing major portion of financial resources of the banking system and as a result low priority was accorded to priority sectors. Government of India nationalized the banks to make them as an instrument of economic and social change and the mandate given to the banks was to expand their networks in rural areas and to give loans to priority sectors such as small scale industries, self-employed groups, agriculture and schemes involving women. To a certain extent the banking sector has achieved this mandate. Lead Bank Scheme enabled the banking system to expand its network in a planned way and make available banking series to the large number of population and touch every strata of society by extending credit to their productive Endeavours. This is evident from the fact that population per office of commercial bank has come down from 66,000 in the year 1969 to 11,000 in 2004. Similarly, share of advances of public sector banks to priority sector increased from 14.6% in 1969 to 44% of the net bank credit. The number of deposit accounts of the banking system increased from over 3 crores in 1969 to over 30 crores. Borrowed accounts increased from 2.50 lakhs to over 2.68 crores. The accumulation of huge non-performing assets in banks has assumed great importance. The depth of the problem of bad debts was first realized only in early 1990s. The magnitude of NPAs in banks and financial institutions is over Rs.1, 50,000 crores. While gross NPA reflects the quality of the loans made by banks, net NPA shows the actual burden of banks. Now it is increasingly evident that the major defaulters are the big borrowers coming from the non-priority sector. The banks and financial institutions have to take the initiative to reduce NPAs in a time bound strategic approach. Public sector banks figure prominently in the debate not only because they dominate the banking industries, but also since they have much larger NPAs compared with 11 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

the private sector banks. This raises a concern in the industry and academia because it is generally felt that NPAs reduce the profitability of banks, weaken its financial health and erode its solvency. For the recovery of NPAs a broad framework has evolved for the management of NPAs under which several options are provided for debt recovery and restructuring. Banks and FIs have the freedom to design and implement their own policies for recovery and write-off incorporating compromise and negotiated settlements.

TYPES OF BANKS:
PUBLIC SECTOR BANKS: Public sector banks are the ones in which the government has a major holding. Public Sector Banks dominate 75% of deposits and 71% of advances in the banking industry. Public Sector Banks control commercial banking India, these can be further classified into: 1) Nationalized banks 2) State Bank of India and its associates 3) Regional Rural Banks

PRIVATE SECTOR BANKS: Private sector banks came into existence to supplement the performance of public sector banks and serve the needs of the economy better. As the public sector banks were merely in the hands of the government, banks had no incentive to make profits and improve their financial capability. The main difference between public and private sector banks is only that public sector banks follow the RBI interest rules strictly but private banks can make some changes in them but only after the approval from the RBI. Private sector banks are the banks which are controlled by the private lenders with the approval from the RBI. Their interest rates are slightly costly as compared to public sector banks.

12 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

NPA (NON PERFORMING ASSET)

Action for enforcement of security interest can be initiated only if the secured asset is classified as Non Performing Asset. Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by RBI. An amount due under any credit facility is treated as "past due" when it has not been paid within 30 days from the due date. Due to the improvement in the payment and settlement systems, recovery climate, up gradation of technology in the banking system, etc., it was decided to dispense with 'past due' concept, with effect from March 31, 2001. Accordingly, as from that date, a Non performing asset (NPA) shell be an advance where interest and /or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan, the account remains 'out of order' for a period of more than 180 days, in respect of an overdraft/ cash Credit(OD/CC), the bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted, interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, and any amount to be received remains overdue for a period of more than 180 days in respect of other accounts. With a view to moving towards international best practices and to ensure greater transparency, it has been decided to adopt the '90 days overdue' norm for identification of NPAs, form the year ending March 31, 2004. Accordingly, with effect from March 31, 2004, a non-performing asset (NPA) shell be a loan or an advance where; interest and /or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan, the account remains 'out of order' for a period of more than 90 days, in respect of an overdraft/ cash Credit(OD/CC), the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, and any amount to be received remains overdue for a period of more than 90 days in respect of other accounts. Non-Performing Asset or NPA, It is called such as while it is an "Asset", it does not bring substantial income to its Owner or is just dormant. Call it a white elephant if you wish. Basically, it is having something that should work but does not. It is supposed to make Non- Performing Assets work. The RBI has issued guidelines to banks for classification of assets into four categories.

13 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

A. Standard (Assets): These are loans which do not have any problem are less risk. B .Substandard (Assets): These are assets which come under the category of NPA for a period of less than 12 months. C. Doubtful (Assets): These are NPA exceeding 12 months. D. Loss (Assets): Where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly.

BENEFICIARIES OF THE STUDY:

The outcomes analyzed from this study would be beneficial to various sections such as: Banks: This study would primarily benefit the banks in identifying the sectors to be given priority for lending money. Future Researchers: The results of the study would also benefit the future researchers as this study would enhance their knowledge about the topic. They would get an insight of the present scenario of this industry as this is the emerging industry in the financial sector of the economy. Students: This research would help students in understanding of NPA concept as a whole.

14 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

NON PERFORMING ASSETS AS A MAJOR ISSUE AND CHALLENGE FOR BANKING INDUSTRY: Non-performing Assets are threatening the stability and demolishing banks profitability through a loss of interest income, write-off of the principal loan amount itself. RBI issued guidelines in 1993 based on recommendations of the Narashimam Committee that mandated identification and reduction of NPAs be treated as a national priority because the level of NPA act as an indicator showing the bankers credit risks and efficiency of allocation of resource. The financial reforms in Indian bank industry have helped largely to clean NPA which was around Rs 52,000 crores in the year 2004. The earning capacity and profitability of the bank are highly affected due to this NPA. GROSS NPA AND NET NPA Gross NPA is an advance which is considered irrecoverable, for bank has made provisions, and which is still held in banks' books of account. Net NPA is obtained by deducting items like interest due but not recovered, part payment received and kept in suspense account from Gross NPA. The Reserve Bank of India states that, compared to other Asian countries and the US, the gross non-performing asset figures in India seem more alarming than the net NPA figure. The problem of high gross NPAs is simply one of inheritance. Historically, Indian public sector banks have been poor on credit recovery, mainly because of very little legal provision governing foreclosure and bankruptcy, lengthy legal battles, sticky loans made to government public sector undertakings, loan waivers and priority sector lending. Net NPAs are comparatively better on a global basis because of the stringent provisioning norms prescribed for banks in 1991 by Narashimam Committee. In India, even on security taken against loans, provision has to be created. Further, Indian banks have to make a 100 per cent provision on the amount not covered by the realizable value of securities in case of ''doubtful'' advance, while in some countries; it is 75 per cent or just 50 per cent. The ASSOCHAM Study titled Solvency Analysis of the Indian Banking Sectors, reveals that on an average 24 per cent rise in net non performing assets have been registered by 25 public sector and commercial banks during the second quarter of the 2009 as against 2008. According to the RBI, "Reduction of NPAs in the Indian banking sector should be treated as a national priority item to make the system stronger, resilient and geared to meet the challenges of globalization. It is necessary that a public debate is started soon on the problem of NPAs and their resolution."

15 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

16 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Review of Literature:
According to a study by Brownbridge (1998), most of the bank failures were caused by nonperforming loans. Arrears affecting more than half the loan portfolios were typical of the failed banks. Many of the bad debts were attributable to moral hazard: the adverse incentives on bank owners to adopt imprudent lending strategies, in particular insider lending and lending at high interest rates to borrowers in the most risky segments of the credit markets. Bloem and Gorter (2001) suggested that a more or less predictable level of non-performing loans, though it may vary slightly from year to year, is caused by an inevitable number of wrong economic decisions by individuals and plain bad luck (inclement weather, unexpected price changes for certain products, etc.). Under such circumstances, the holders of loans can make an allowance for a normal share of non-performance in the form of bad loan provisions, or they may spread the risk by taking out insurance. Enterprises may well be able to pass a large portion of these costs to customers in the form of higher prices. For instance, the interest margin applied by financial institutions will include a premium for the risk of nonperformance on granted loans. At this time, banks non-performing loans increase, profits decline and substantial losses to capital may become apparent. Eventually, the economy reaches a trough and turns towards a new expansionary phase, as a result the risk of future losses reaches a low point, even though banks may still appear relatively unhealthy at this stage in the cycle. According to Gorter and Bloem (2002) non-performing loans are mainly caused by an inevitable number of wrong economic decisions by individuals and plain bad luck (inclement weather, unexpected price changes for certain products, etc.). Under such circumstances, the holders of loans can make an allowance for a normal share of nonperformance in the form of bad loan provisions, or they may spread the risk by taking out insurance. Petya Koeva (2003), his study on the Performance of Indian Banks. During Financial Liberalization states that new empirical evidence on the impact of financial liberalization on the performance of Indian commercial banks. The analysis focuses on examining the behavior and determinants of bank intermediation costs and profitability during the liberalization period. The empirical results suggest that ownership type has a significant effect on some performance indicators and that the observed increase in competition during financial liberalization has been associated with lower intermediation costs and profitability of the Indian banks. Das and Ghosh (2003) empirically examined non-performing loans of Indias public sector banks in terms of various indicators such as asset size, credit growth and macroeconomic condition, and operating efficiency indicators. Sergio (1996) in a study of non-performing loans in Italy found evidence that, an increase in the riskiness of loan assets is rooted in a banks lending policy adducing to relatively unselective and inadequate assessment of sectoral prospects. 17 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Vradi et.al (2006), his study on Measurement of efficiency of bank in India concluded that in modern world performance of banking is more important to stable the economy .in order to see the efficiency of Indian banks we have see the fore indicators i.e. profitability, productivity, assets, quality and financial management for all banks includes public sector, private sector banks in India for the period 2000 and 1999 to 2002-2003. For measuring efficiency of banks we have adopted development envelopment analysis and found that public sectors banks are more efficient then other banks in India Brijesh K. Saho et.al (2007), this paper attempts to examine, the performance trends of the Indian commercial banks for the period: 1997-98 - 2004-05. Our broad empirical findings are indicative in many ways. First, the increasing average annual trends in technical efficiency for all ownership groups indicate an affirmative gesture about the effect of the reform process on the performance of the Indian banking sector. Second, the higher cost efficiency accrual of private banks over nationalized banks indicate that nationalized banks, though old, do not reflect their learning experience in their cost minimizing behavior due to X-inefficiency factors arising from government ownership. This finding also highlights the possible stronger disciplining role played by the capital market indicating a strong link between market for corporate control and efficiency of private enterprise assumed by property right hypothesis. And, finally, concerning the scale elasticity behavior, the technology and market-based results differ significantly supporting the empirical distinction between returns to scale and economies of scale, often used interchangeably in the literature. Roma Mitra et.al (2008), A stable and efficient banking sector is an essential precondition to increase the economic level of a country. This paper tries to model and evaluate the efficiency of 50 Indian banks. The Inefficiency can be analyzed and quantified for every evaluated unit. The aim of this paper is to estimate and compare efficiency of the banking sector in India. The analysis is supposed to verify or reject the hypothesis whether the banking sector fulfils its intermediation function sufficiently to compete with the global players. The results are insightful to the financial policy planner as it identifies priority areas for different banks, which can improve the performance. This paper evaluates the performance of Banking Sectors in India. B.Satish Kumar (2008), in his article on an evaluation of the financial performance of Indian private sector banks wrote Private sector banks play an important role in development of Indian economy. After liberalization the banking industry underwent major changes. The economic reforms totally have changed the banking sector. RBI permitted new banks to be started in the private sector as per the recommendation of Narashiman committee. The Indian banking industry was dominated by public sector banks. But now the situations have changed new generation banks with used of technology and professional management has gained a reasonable position in the banking industry. 18 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

M. Karunakar et.al (2008), Study the important aspect of norms and guidelines for making the whole sector vibrant and competitive. The problem of losses and lower profitability of NonPerforming Assets (NPA) and liability mismatch in Banks and financial sector depend on how various risks are managed in their business. Besides capital to risk Weightage assets ratio of public sector banks, management of credit risk and measures to control the menace of NPAs are also discussed. The lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. It is better to avoid NPAs at the market stage of credit consolidation by putting in place of rigorous and appropriate credit appraisal mechanisms. Nelson M. Waweru et.al (2009), Study that many financial institutions that collapsed in Kenya since 1986 failed due to non performing loans, this study investigated the causes of nonperforming loans, the actions that bank managers have taken to mitigate that problem and the level of success of such actions. Using a sample of 30 managers selected from the ten largest banks the study found that national economic downturn was perceived as the most important external factor. Customer failure to disclose vital information during the loan application process was considered to be the main customer specific factor. The study further found that Lack of an aggressive debt collection policy was perceived as the main bank specific factor, contributing to the non performing debt problem in Kenya. Kevin Greenidge et.al (2010), study the evaluation of non-performing loans is of great importance given its association with bank failure and financial crises, and it should therefore be of interest to developing countries. The purpose of this paper is to build a multivariate model, incorporating macroeconomic and bank-specific variables, to forecast non-performing loans in the banking sector of Barbados. On an aggregate level, our model outperforms a simple random walk model on all forecast horizons, while for individual banks; these forecasts tend to be more accurate for longer prediction periods only.

19 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

20 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

RESEARCH PROBLEM:
Indian banking industry, which was in glory phase once upon a time, has been facing a lots of challenges on non performing assets at present scenario. Many banks have kept their NPAs under the control but some banks are not able to control their NPA levels. They are facing lots of problems. There can be various reasons behind this NPA. Non-performing assets has been hitting the profitability of the banks or it can be said that due to NPA, the profitability of the banks are going down day by day. The subsidiary for this is the functioning of Debt Recovery Tribunal (DRT) which is a judiciary for the bank for recovery amount from the default customers. These can be considered as a research problem based on which the information is collected, the object is measured and the data is analyzed and interpreted.

OBJECTIVES OF THE STUDY:

The objective of the project was to find how this Non-Performing Assets generate and what its impact on the profitability of the bank and how it can be reduced. The study is addressed to the following objectives: To study the trend of NPAs during last nine years. To determine the factors affecting NPA. To find out the effectiveness of recovery mechanism adopted by banks for NPA. To establish relationship between NPAs and profitability of private banks. To suggest measures to reduce NPAs in private sector.

NEED OF THE STUDY:

The non-performing assets that are not able to generate income for the bank are the great threat for the banking institution. Rather than generating profit for the bank, NPA drains off the income earned by the other performing asset by the way of paying interest to the real owner of the resources. It affects the overall profitability of the bank adversely by affecting the return on equity and return on asset. There are certain ways through which it affects the financial institutions are as follows: Thus, the need of the study of the NPA is must necessary due to these reasons. These reasons are the crucial for any bank at present. One has to realize these matters and has to take corrective action against NPA reasons, as for as possible one has to convert all the NPA accounts into PA accounts. As far as the importance of the study is concern, without the study, one cant identify the whole gamut of the NPA. To know, how the account is becoming NPA is must necessary. After identifying the reason behind the particular NPA account, one can go for a step ahead. That means for the step of how to convert into PA and how to prevent other account from becoming 21 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

NPA. As for as possible, one has to eradicate the reasons of NPAs. Thus, it is highly importance to study NPA in detail.

SCOPE OF THE STUDY:

Being a project scope will be based on the day-to-day teamwork operations. The data will be collected from various aspects of loans and advances in various private banks of Jalandhar and Phagwara (Punjab). To understand the concept of NPA in Indian Private Banking industry. To understand the causes of NPA. To analyze the past trends of NPA of Private banks.

HYPOTHESES FORMULATION:
H1: There exists a relationship between NPAs and profitability of private banks. H2: The recovery mechanisms adopted by private banks are effective.

COLLECTION OF DATA:
The relevant data was collected from both primary and secondary sources. Census method of data collection was applied to collect primary information. Research population for the study comprised of private banks operating in Jalandhar and Phagwara (Punjab). The response rate for the present study came to be 86.66 % since 13 banks responded out of 15 private banks in the concerned area. The 13 banks surveyed are 1) Axis Bank, 2) Citi Bank, 3) Federal Bank; 4) HDFC Bank, 5) ICICI Bank, 6) IndusInd Bank, 7) ING Vysya Bank, 8) Karnataka Bank, 9) Karur Vysya Bank, 10) Kotak Mahindra Bank, 11) South Indian Bank, 12) Jammu and Kashmir Bank, 13) IDBI Bank. The secondary sources comprised of various audited reports and publications of the Reserve Bank of India. Detailed information were collected mainly from the various volumes of the Statistical Tables Relating to Banks in India covering the period from 2000 - 2009 which were published by the Statistical Department of Reserve Bank of India, Mumbai from the website www.rbi.org.in.

22 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

DATA COLLECTION FORM:

A structured questionnaire assessing work system, recovery system, processing loan applications and other impeding factors associated with loan portfolio was used to collect primary information from the private banks. Items based on 5-point Likert scale and multiple chioce questions were included in the questionnaire.

STATISTICAL TOOLS:
The analyses of primary data were conducted through descriptive statistics, factor analysis, Pearson correlation and one-sample t-test. The secondary data was analyzed through column charts, line charts, bar charts and percentages.

LIMITATIONS:
1. The secondary data was available for 9 years only. 2. The present study is confined to Jalandhar and Phagwara areas only. 3. The conclusions of the study are based on the responses of the banks and secondary information. Thus, some amount of subjectivity might remain.

23 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

24 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

ANALYSES OF PRIMARY DATA:

I) MULTIPLE CHOICE QUESTIONS:
Table: 1 Since how long the branch is functioning? Percentage Frequency Valid 0-2 years 2-3 years 3-5 years 5- years above Total 1 2 5 5 13 (%) 7.7 15.4 38.5 38.5 100.0 Valid Percent 7.7 15.4 38.5 38.5 100.0 Cumulative Percent 7.7 23.1 61.5 100.0

Interpretation: 39% of banks surveyed showed 3-5 years of functioning experience. Also, the same percentage (39%) was found to have an experience above 5 years.

Table : 2 Since how long the presence of NPA is observed in your Percentage Frequency Valid 0-1yrs 1-2yrs above -5yrs Total 3 7 3 13 (%) 23.1 53.8 23.1 100.0 Valid Percent 23.1 53.8 23.1 100.0 Cumulative Percent 23.1 76.9 100.0

Interpretation: 54% of banks observed NPA in their branch from 1-2 years.

25 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Table: 3 What is the appropriate value of NPA is your branch? (Rs in lakhs) Percentage Frequency Valid 1-10 10-20 20-30 above - 40 Total 5 6 1 1 13 (%) 38.5 46.2 7.7 7.7 100.0 Valid Percent 38.5 46.2 7.7 7.7 100.0 Cumulative Percent 38.5 84.6 92.3 100.0

Interpretation: 46% of banks have 20 lakhs (approximate) of NPAs and 39% of banks have 1-10 lakhs (approximate) NPA.

Table : 4 For which category the NPA is being observed Percentage Frequency Valid Personal loan Housing loan Agri-term loan Total 6 6 1 13 (%) 46.2 46.2 7.7 100.0 Valid Percent 46.2 46.2 7.7 100.0 Cumulative Percent 46.2 92.3 100.0

Interpretation: 46.2% banks observed NPAs are in the category of personal loans, also, same percentage (46.2%) observed NPAs in housing loans category.

26 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Table : 5 Measures for recovery of NPA adopted by the bank Percentage Frequency Valid Legal measures Both legal and non-legal Total 6 7 13 (%) 46.2 53.8 100.0 Valid Percent 46.2 53.8 100.0 Cumulative Percent 46.2 100.0

Interpretation: 53.8% banks adopted both legal and non-legal measures of recovery whereas 46.2% banks adopted legal measures only.

Table: 6 To what extent NPA has been converting into good asset. Percentage Frequency Valid 1% 2% 4% 5% >5% Total 1 1 1 1 9 13 (%) 7.7 7.7 7.7 7.7 69.2 100.0 Valid Percent 7.7 7.7 7.7 7.7 69.2 100.0 Cumulative Percent 7.7 15.4 23.1 30.8 100.0

Interpretation: After survey 69.2% banks showed that they could convert more than 5% NPA into good assets.

27 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Table: 7 Has the profitability improved after adopting reduction technique? Percentage Frequency Valid Definitely improved improved Cant say Total 5 7 1 13 (%) 38.5 53.8 7.7 100.0 Valid Percent 38.5 53.8 7.7 100.0 Cumulative Percent 38.5 92.3 100.0

Interpretation: 53.8% banks showed that their profitability improved and 38.5% banks confirmed that their profitability definitely improved after adopting NPA reduction techniques.

II) FACTOR ANALYSIS:

Factorial profile of recovery mechanism adopted for NPA by banks
Table: 8

No. of No. of rounds factors 1 2 3 3

Communalities Iterations KMO Items (Above) (Above) Deleted .60 .65 4 5 .45 .34 1 -

Items V.E Remained % 8 7 80.36 80.81

Factor Loading (Above) .55 .70

28 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Descriptive Statistics of Factors affecting NPAs: Table: 9

Mean Factors Standard Deviation Factor Loading Communality Variance Cronbach Explained s Alpha (%) 28.79 .721

F1 Recession and management failure 3.15 Recession in economy 3.00 Management Failure 28.39 F2 Execution Problems 2.92 Improper Credit Appraisal Difficulty in executing Repayment procedure Cost of effective legal measures 3.46 2.46 1.115 .967 1.391 .850 .827 .730 .762 .713 .694 23.62 F3 Default by customers 2.77 Willful Default 2.15 Absence of Security 1.281 .854 .960 1.235 .914 .927 .753 .709 1.780 .837 .710 .987 .940 .891

Interpretation: Factors affecting NPAs were subjected to data purification, which resulted into three factors, with KMO value = 0.34, variance explained = 80.81%, communalities above .65 and Cronbachs Alpha above .70. The factors extracted were Recession and management failure, Execution Problems and Default by customers.

29 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Factorial profile of recovery mechanism adopted for reducing NPA

Table: 10

No. of No. of rounds factors 1 2 2 2

Communalities Iterations KMO (Above) (Above) .15 .85 3 3 .45 .50

Items Deleted 2 -

Items V.E Remained % 6 4 73.43 89

Factor Loading (Above) .50 .85

Descriptive Statistics of Recovery Mechanisms adopted to reduce NPAs:

Table: 11

Mean Factors F1 Banking Measures Self involvement Recovery campus F2 Legal Measures Lok adalats SARFASI Act 2.31 1.85 2.08 2.00

Standard Deviation

Factor Loading

Communality

Variance Cronbach Explained s Alpha (%) 48.25 .912

1.256 1.414

.960 .951

.923 .910 41.71 .793

1.494 1.214

.932 .891

.892 .874

Interpretation: Factor analysis was run on the recovery mechanism adopted by private banks for reducing NPAs which completed in two rounds after deleting two items, one with communality below 0.50 and other with missing factor loading. Finally, two factors emerged Banking Measures and Legal Measures, with KMO value of .50, variance explained = 89%, communalities above .85 and Cronbachs Alpha .80.

30 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

III) TESTING OF HYPOTHESES: H1: There exists a relationship between NPAs and profitability of private banks.
Table: 12 Pearson Correlation Net NPA Net NPA Pearson Correlation Sig. Net Profit Pearson Correlation Sig. .480 .191 1 Net Profit .480 .191 1

Interpretation: Pearson correlation was applied to test this hypothesis. The value of coefficient of correlation r obtained was .480. Since the significance value was above 0.05 (p =.191), it shows that NPA and profitability of private banks surveyed is uncorrelated. Thus this hypothesis is rejected.

H2: The recovery mechanisms adopted by private banks are effective.

Table: 13

Factors F1 F2

One- sample t-test (Test value = 2) t df .108 .224 12 12

Sig. level .916 .827

Interpretation: This hypothesis was tested through one sample t-test. Overall mean calculated was 2.06 and both the factors were compared with the test value = 2. Both the factors were found to be insignificant, thus hypothesis stands rejected. This implies that the recovery mechanism adopted by private banks to reduce NPAs is not effective.

31 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

ANALYSIS & INTERPRETATION OF SECONDARY DATA:

I. ANALYSIS OF TREND AND ASSET QUALITY OF GROSS ADVANCES AND GROSS NON PERFORMING ASSETS:

Table 1.1: GROSS ADVANCES AND GROSS NPAs OF PRIVATE SECTOR BANKS Gross NPAs Percent to Gross Advances Amount(cr.) 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 Interpretation: The following table helps in examining trends of gross advances, gross NPAs, ratio of gross NPAs to gross advances and ratio of gross NPAs to total assets. We can also visualize the trend of private sector banks by using gross advances, gross NPAs and ratios of gross NPA to gross advances and total assets. We can clearly see from the above table that the gross advances are increasing continuously and there is an increase of over 721 percent as compared to 2000-01 and 2008-09. This clearly shows that apart from the presence of private sector banks also get a great opportunity to prove them. The amount of gross NPAs shows a mix kind of trend over a periodas till 2002-03 and from 2005-06 to 2008-09 there is a continuous increase in gross NPA amount while there is a decrease in it from a period ranging from 2003-04 to 2005-06. NPA ratios related to gross NPA also shows a mix trend over a period. But if we see the last three years data, we can clearly see that there is an increase in gross NPA to total assets and gross NPA to gross advances which means that the asset quality is diminishing instead of improving. Thus, if we compare both public and private sector banks we can say that public sector banks are better than private sector banks as the efficiency and asset quality of public sector banks had shown a continuous improvement if compare relatively to private sector banks. 32 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks 71237 120958 146047 177419 197832 317690 420745 525845 585065 5963 11662 11782 10381 8782 7811 9256 12983 16983 8.4 9.6 8.1 5.9 4.4 2.5 2.2 2.5 2.9 3.4 4.4 4 2.8 2.1 1.4 1.2 1.4 1.7

Years

Gross Advances(cr.)

Percent to Total Assets

II. ANALYSIS OF TREND AND ASSET QUALITY OF NET ADVANCES ON NET NON PERFORMING ASSETS:

Table 1.2: NET ADVANCES AND NET NPAS OF PRIVATE SECTOR BANKS Net NPAs Percent to Net Advances 5.4 5.7 2.8 2.4 2.2 1 1 1.1 1.3

Years

Net Advances(cr.) Amount(cr.) 68059 3700 116473 138951 170754 191397 312962 414752 518403 575336 6676 3963 4128 4212 3171 4028 5607 7418

Percent to Total Assets 2.3 2.5 2.3 1.3 1 0.6 0.5 0.6 0.7

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Interpretation: After the analysis of gross advances and gross NPA, the study investigates the net advances; net NPAs, ratio of net NPAs to net advances and net NPAs to total assets. If we use the same criteria for private sector banks, we can see despite of continuous increase in net advances in all years the net NPA ratio to net advances and total assets increases in last 2-3 years that is in 2007-08 and 2008-09 while all other years shows a decreasing trend. That means only in last 2-3 years the efficiency and asset quality of private sector banks is questionable otherwise in all other previous years the banks had shown a continuous improvement. As, if we see overall performance of the private sector banks we can say that there is a wide improvement as the net NPA ratios changes from 5.4 to 1.3 and from 2.3 to 0.7. Thus, after comparing both the gross and net NPA ratio, if we compare Private sector banks are much more efficient than other sector banks.

33 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

OBJECTIVE 1: The trend of NPA in last nine years was analyzed through secondary data. The percentages of both gross and net NPA to gross and net advances were found to increase during first two years but continuously decrease after 2001 2002.

CLASSIFICATION OF LOAN ASSETS OF NPAS OF PRIVATE SECTOR BANKS

Table: 1.3

Years

Classification of Loan Assets (Amount in Rs. Crore) Sub-standard Standard Assets Assets Doubtful Assets Loss Assets Amoun Amount %age Amount %age Amount %age t %age 65071 109216 131620 167076 216448 309051 382628 459369 561546 91.5 90.3 90.8 94.2 96.1 97.6 97.6 97.3 97.1 2585 4738 3703 3127 2213 2424 4378 7280 10553 3.6 3.9 2.6 1.8 1.0 0.8 1.1 1.5 1.8 3069 6539 8512 6391 5578 4348 3923 4452 4975 4.3 5.4 5.9 3.6 2.5 1.4 1 0.9 0.9 424 390 1118 825 900 939 941 1244 1324 0.6 0.3 0.8 0.5 0.4 0.3 0.2 0.3 0.2

2001 2002 2003 2004 2005 2006 2007 2008 2009

Interpretation: If we analyze the loan assets of private sector banks, we can say that if we compare the first year and last year for sub standard assets we can say that there is a decrease in it of health is improving but overall analysis for sub-standard assets shows that after year 2006 there is a continuous increase in the amount of sub-standard assets i.e. from 1percent to 1.8 percent. But, the doubtful assets have declined from 5.9percent in 2003 to 0.9 percent in 2009. The loss assets also have shown a decreasing trend from year 2003. Thus, we can say that except the substandard assets category the other two categories of non-performing assets have improved over the period of study.

34 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Net NPAs & Net Profit of Private Sector Banks: 2000-01 to 2008-09
Table: 1.4

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Net NPA 3700 6676 3963 4128 4212 3171 4028 5380 7418

Net Profit 1142 1779 2958 3481 3533 4975 6465 9522 10868

12000 10000 8000 6000 Net NPA 4000 2000 0 Net Profit

Interpretation: It is clearly observed from the line graph that there is continuous rise in net profit of private sector banks over the years. The average of percentage increase in net profits of private sector banks comes to approximately 34%.
On the contrary there is no continuous rise/fall in net NPA. But overall there is rise in net NPA from 2000-01 to 2008-09. The average of percentage rise in net NPA comes to almost 15%.

35 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Classification of Loan Asset of Private Sector Banks in percentage:

Table: 1.5

Year 2004 2005 2006 2007 2008 2009

Standard Asset (%) 94.2 96.1 97.4 97.6 97.3 96.8

SubStandard Asset (%) 1.8 1.0 0.8 1.1 1.5 2.0

Doubtful Asset (%) 3.6 2.5 1.5 1.0 0.9 1.0

Loss Asset (%) 0.5 0.4 0.3 0.2 0.3 0.3

0.5

0.4 2.5

0.3 1.5

0.2 1 1.1

0.3 0.9 1.5

0.3 1 2 Loss Asset Doubtful Asset Sub-Standard Asset

3.6 1 1.8

0.8

97.4 96.1 94.2

97.6

97.3

96.8

Standard Asset

2004

2005

2006

2007

2008

2009

Interpretation: The above chart clearly states that the rise in the standard assets over the years compensates the fall in the other three types of assets. But in the year 2009, the percentage of Sub Sub-Standard asset is highest among all the year. In 2009 percentage of sta standard ndard asset has reduced by 0.5% which is compensated by increase in Sub Sub-Standard Standard & doubtful assets. This increase is due to interest & principle amount unpaid due to financial crisis in 2009. The percentage of doubtful asset has reduced to a great extent amongst mongst all. So the private sector banks have managed to reduce the doubtful asset.

36 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Net NPA to Net Advance Ratio of Private Sector Banks:

Table: 1.6

Years 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Old Private Sector Banks 7.3 7.1 5.2 3.8 2.7 1.7 1 0.7 0.9

New Private Sector Banks 3.1 4.9 1.5 1.7 1.9 0.8 1 1.1 1.3

8 7 6 5 4 3 2 1 0 Old Private Sector Banks New Private Sector Banks

Interpretation: From the above chart it is clearly observed that old private sector banks are constantly improving in terms of net NPA to net advances ratio which is represented by declining trend from 2000-01 to 2008-09. While on the other hand for new private sector banks net NPA to net advances ratio is fluctuating over the years.

37 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Net NPAs of Old and New Private Sector Banks: 2000-01 to 2008-09
Table: 1.7

Year 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09

Old Private Sector Banks 2,771 3,013 2,598 2,142 1,859 1,375 891 740 1165

New Private Sector Banks 929 3,663 1,365 1,986 2,353 1,796 3,137 4640 6253

7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Old Private Sector Banks New Private Sector Banks

Interpretation: From the above chart it is clearly observed that net NPA of old private sector banks has a declining trend over the years on the contrary new private sector banks has an upward trend. Old private sector banks which is passing from lower growth rate in recent past, starts performing better than their new counterparts. Old private sector banks are more efficient than that of new private sector banks in managing NPA.

38 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Composition of NPAs of Private Sector Banks - 2001 To 2009:

Table: 1.8

Year 2001 2002 2003 2004 2005 2006 2007 2008 2009

Priority Sector 1835 2546 2445 2482 2188 2284 2884 3419 3640

Non-Priority Sector 4452 9090 9327 7796 6569 5541 6353 9558 13172

Public Sector 123 31 95 75 42 4 3 0 75

14000 12000 10000 8000 6000 4000 2000 0 1 2 3 4 5 6 7 8 9 Priority Sector Non-Priority Sector Public Sector

Interpretation: From the above graph it is observed that Priority sector category on an average constitutes almost 34% of the total advances made by the private sector banks. While average NPA of priority sector constitutes of 25% of total NPA. In later years from 2007 to 2009 there is increase in NPA of priority sector. In these years more advances was given to agriculture & housing sector. 39 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

In the year 2007-08, the real estate market was on boom, which encouraged people to take more loans. But after the subprime crisis there was sudden fall in real estate market & people became default to pay the loan. In case of non-priority sector, the average advances made are 60.5% of total advance made by private sector banks. But the average NPA of non-priority sector is almost 74% which is highest amongst the entire category. We can see the declining trend in NPA of non-priority sector from 2003 to 2006, this as a result of securitization Act, 2002.

NPA ratios of Private Sector Banks: 2004-05 to 2008-09

Table: 1.9

Year

Gross Net NPAs/Net NPAs/Gross Advances Advances

2004-05 2005-06 2006-07 2007-08 2008-09

3.8 2.5 2.2 2.5 2.9

1.9 1 1 1.2 1.5

4 3.5 3 2.5 2 1.5 1 0.5 0

3.8

2.9 2.5 2.2 1.9 1.5 1 1 1.2 2.5 Gross NPAs/Gross Advances Net NPAs/Net Advances

2004-05

2005-06

2006-07

2007-08

2008-09

40 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Interpretation: The percentage change in of gross NPA to gross advances ratio is decreasing initially & thereafter started rising from 2006-07. It has reduced by 34.2% from 2004-05 to 2005-06. Similarly it has reduced by 12% from 2005-06 to 2006-07 & thereafter increased by 18.5% & 9% respectively from 2006-07 to 2007-08 & 2007-08 to 2008-09. While in case of net NPA to net advances ratio, the percentage change is varying drastically. It has reduced by 47% from 2004-05 to 2005-06. It is unchanged from 2005-06 to 2006-07. It has increased by 20% & 25% respectively from 2006-07 to 2007-08 & 2007-08 to 2008-09. The percentage change in gross NPA to gross advances ratio & net NPA to net advances ratio over the years states that private sector banks makes more provisions in gross NPA & gross advances. The difference in gross NPA/ gross advances & net NPA/net advances is highest in 2005-06 [60%] & lowest in 2008-09 [48%]. In other years it near to 54%, in 2006 there is highest increase in advances over previous year amongst all the year. This resulted increase in NPA which in turn increased the provisions and unrecognized interest income. Private sector banks have not succeeded to reduce NPA as against the advances made over the years as both the ratios are increasing in later years.

41 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

REASONS FOR AN ACCOUNT BECOMING NPA: 1. Internal factors 2. External factors Internal factors: Funds borrowed for a particular purpose but not use for the said purpose. Project not completed in time. Poor recovery of receivables. Excess capacities created on non-economic costs. In-ability of the corporate to raise capital through the issue of equity or other debt instrument from capital markets. Business failures. Diversion of funds for expansion\modernization\setting up new projects\ helping or promoting sister concerns. Willful defaults, siphoning of funds, fraud, disputes, management disputes, misappropriation etc. Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups, delaying settlement of payments\ subsidiaries by government bodies etc.,

External factors: 1) Sluggish legal system: Long legal tangles Changes that had taken place in labor laws 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.

42 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

5) Failures, nonpayment\ over dues in other countries, recession in other countries, externalization problems, adverse exchange rates etc.

IMPACT OF NPAS ON BANK PERFORMANCE:

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 deleterious impact on the return on assets in the following ways. The interest income of banks will fall and it is to be accounted only on receipt basis. Banks profitability is affected adversely because of the providing of doubtful debts and consequent to writing it off as bad debts. Return on investments (ROI) is reduced. The capital adequacy ratio is disturbed as NPAs are entering into its calculation. The cost of capital will go up. The assets and liability mismatch will widen. The economic value addition (EVA) by banks gets upset because EVA is equal to the net operating profit minus cost of capital and It limits recycling of the funds.

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 Camels supervisory rating system of RBI: Profitability: NPA means booking of money in terms of bad asset, which occurred due to wrong choice of client. Because of the money getting blocked the prodigality of bank decreases not only by the amount of NPA but NPA lead to opportunity cost also as that much of profit invested in some return earning project/asset. So NPA doesnt affect current profit but also future stream of profit, which may lead to loss of some long-term beneficial opportunity. Another impact of reduction in profitability is low ROI (return on investment), which adversely affect current earning of bank. Liquidity: Money is getting blocked, decreased profit lead to lack of enough cash at hand which lead to borrowing money for shortest period of time which lead to additional cost to the company. Difficulty in operating the functions of bank is another cause of NPA due to lack of money. 43 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Involvement of Management: Time and efforts of management is another indirect cost which bank has to bear due to NPA. Time and efforts of management in handling and managing NPA would have diverted to some fruitful activities, which would have given good returns. Now day
s banks have special employees to deal and handle NPAs, which is additional cost to the bank. Credit Loss: Bank is facing problem of NPA then it adversely affect the value of bank in terms of market credit. It will lose its goodwill and brand image and credit which have negative impact to the people who are putting their money in the banks.

Early Symptoms: By which one can recognize a performing asset turning in to non-performing asset Four categories of early symptoms:1) Financial: Non-payment of the very first installment in case of term loan. Bouncing of cheque due to insufficient balance in the accounts. Irregularity in installment. Irregularity of operations in the accounts. Unpaid overdue bills. Declining Current Ratio. Payment which does not cover the interest and principal amount of that installment. While monitoring the accounts it is found that partial amount is diverted to sister concern or parent company.

2) Operational and Physical: If information is received that the borrower has either initiated the process of winding up or are not doing the business. Overdue receivables. Stock statement not submitted on time. 44 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

External non-controllable factor like natural calamities in the city where borrower conduct his business. Frequent changes in plan. Nonpayment of wages.

3) Attitudinal Changes: Use for personal comfort, stocks and shares by borrower. Avoidance of contact with bank. Problem between partners.

4) Others: Changes in Government policies. Death of borrower. Competition in the market

CREDIT DEFAULT SWAP:

It is a bilateral financial contract in which buyer pays a periodic fee expressed in fixed basis points on the notional amount in return for a floating payment contingent on the default of a third party reference credit. The floating payment is designated to mirror the loss incurred by creditors of the reference credit in the event of its default. The credit event various from bank to bank and from transaction to transaction, the credit events are pre defined in the agreement, which includes (i) Bankruptcy, (ii) Insolvency (iii) Rating, and downgrading below agreed threshold (iv)Failure to adjust for new payment obligation and (v) Debt Rescheduling. The credit event triggers the obligation of the seller of default protection to the purchaser of the same. The investors who need to protect themselves against default but do not want to sell them at risk security for accounting, tax and regulatory reasons can buy a credit default swap.

CREDIT LIMITED NOTES (CLN):

These are known as credit swaps in which buyer makes periodic payments of a fixed percentage of the reference asset to the seller over the life of the swap. Then the seller promises a payment in the case of credit default for the reasons viz., bankruptcy, delinquency and credit rating down grade. The payments may be either a pre - determined amount and also decrease in the market value of the reference obligation that may cause the credit event. The seller calls the structure away from the investor and delivers the defaulting notes against them on the happening of credit 45 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

event. The CLN are like bonds in character and are acceptable to certain banks. They are not allowed to involve in credit default swap.

CONSEQUENCES OF NPAS:
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. The NPAs in the public sector banks are well above the normal level. The consequences envisaged during the past several years are many. It has become a difficult task for the banks to reduce the lending rate due to the presence of large NPAs. Ultimately this is affecting the competitiveness of the Indian banks. When the bank does not enjoy the market competitiveness naturally the credit expansion would be slumped and when it happens, the profitability gets a setback. In this way the vicious circle will go on and on. Another important one is the reduction in the availability of funds for further expansion due to the unproductiveness of the existing portfolio. Sometimes it is found that the presence of large NPAs discourages banks to accept profitable but risky proposal loan from the customers. The NPAs also affect the risk taking ability of the banks. On the whole it affects the credibility of the bank and faces difficulty in raising fresh capital from the market for future requirements.

MEASURES TO CONTROL NPAs:

It is proved beyond doubt that NPAs in bank ought to be kept at the lowest level. Two pronged approaches viz., (i) Preventive management and (ii) Curative management would be necessary for controlling NPAs.

1. Preventive Management:
a) Credit Assessment and Risk Management Mechanism: A lasting solution to the problem of NPAs can be achieved only with proper credit assessment and risk management mechanism. The documentation of credit policy and credit audit immediately after the sanction is necessary to upgrade the quality of credit appraisal in banks. In a situation of liquidity overhang the enthusiasm of the banking system is to increase lending with compromise on asset quality, raising concern about adverse selection and potential danger of addition to the NPAs stock. It is necessary that the banking system is equipped with prudential norms to minimize if not completely avoid the problem of credit risk.

46 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

b) Organizational Restructuring: With regard to internal factors leading to NPAs the onus for containing the same rest with the bank themselves. These will necessities organizational restructuring improvement in the managerial efficiency, skill up gradation for proper assessment of credit worthiness and a change in the attitude of the banks towards legal action, which is traditionally viewed as a measure of the last resort. c) Reduce Dependence on Interest: The Indian banks are largely depending upon lending and investments. The banks in the developed countries do not depend upon this income whereas 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. d) Potential and Borderline NPAs under Check: The potential and borderline accounts require quick diagnosis and remedial measures so that they do not step into NPAs categories. The auditors of the banking companies must monitor all outstanding accounts in respect of accounts enjoying credit limits beyond cut off points, so that new sub-standard assets can be kept under check.

2. Curative Management:
The curative measures are designed to maximize recoveries so that banks funds locked up in NPAs are released for recycling. The Central government and RBI have taken steps for arresting incidence of fresh NPAs and creating legal and regulatory environment to facilitate the recovery of existing NPAs of banks. They are: Debt Recovery Tribunals (DRT): In order to expedite speedy disposal of high value claims of banks Debt Recovery Tribunals were setup. The Central Government has amended the recovery of debts due to banks and financial institutions Act in January 2000 for enhancing the effectiveness of DRTs. The provisions for placement of more than one recovery officer, power to attach dependents property before judgment, penal provision for disobedience of Tribunals order and appointment of receiver with powers of realization, management, protection and preservation of property are expected to provide necessary teeth to the DRTs and speed up the recovery of NPAs in times to come. a) Lok Adalats: The Lok adalats institutions help banks to settle disputes involving accounts in doubtful and loss categories. These are proved to be an effective institution for settlement of dues in respect of smaller loans. The Lok adalats and Debt Recovery Tribunals have been empowered to organize Lok adalats to decide for NPAs of Rs. 10 lakhs and above.

47 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

b) Asset Reconstruction Company (ARC): The Narasimham Committee on financial system (1991) has recommended for setting up of Asset Reconstruction Funds (ARF). The following concerns were expressed by the committee. It was felt that centralized all India fund will severely handicap in its recovery efforts by lack of widespread geographical reach which individual bank posses and. Given the large fiscal deficits, there will be a problem of financing the ARF. Subsequently, the Narasimham committee on banking sector reforms has recommended for transfer of sticky assets of banks to the ARC. Thereafter the Varma committee on restructuring weak public sector banks has also viewed the separation of NPAs and its transfer thereafter to the ARF is an important element in a comprehensive restructuring strategy for weak banks. In recognition of the same ARC Bill was passed to regulate Securitization and Reconstruction of financial assets and enforcement of security interest. The ICICI BANK has promoted the countrys first Asset Reconstruction Company. The company is specialized in recovery and liquidation of assets. The NPAs can be assigned to ARC by banks at a discounted price. The objective of ARC is floating of bonds and making necessary steps for recovery of NPAs from the borrowers directly. This enables a onetime clearing of balance sheet of banks by sticky loans. c) Corporate Debt Restructuring (CDR): The corporate debt restructuring is 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 BIFR, DRT and other legal proceedings for the benefit of concerned. The CDR has three tier structure viz., a. CDR standing forum b. CDR empowered group and c. CDR cell. The Mechanism of the CDR: It is a voluntary system based on debtors and creditors agreement. It will not apply to accounts involving one financial institution or one bank instead it covers multiple banking accounts, syndication, consortium accounts with outstanding exposure of Rs. 20 crores and above by banks and institutions. The CDR system is applicable to standard and sub standard accounts with potential cases of NPAs getting a priority. In addition to the steps taken by the RBI and Government of India for arresting the incidence of new NPAs and creating legal and regulatory environment to facilitate for the recovery of existing NPAs of banks, the following measures were initiated for reduction of NPAs. Circulation of Information of Defaulters: The RBI has put in place a system for periodical circulation of details of willful defaulters of banks and financial institutions. The RBI also publishes a list of borrowers (with outstanding aggregate rupees one crore and above) against whom banks and financial institutions in recovery of funds have filed suits as on 31st March every year. It will serve as a caution list while considering a request for new or additional credit limits from defaulting borrowing units and also from the directors, proprietors and partners of these entities.

48 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

d) Recovery Action against Large NPAs: The RBI has directed the PSBs to examine all cases of willful default of Rs. One crore and above and file criminal cases against willful defaulters. The board of directors are requested to review NPAs accounts of one crore and above with special reference to fix staff accountability in individually. e) Credit Information Bureau: The institutionalization of information sharing arrangement is now possible through the newly formed Credit Information Bureau of India Limited (CIBIL) It was set up in January 2001, by SBI, HDFC, and two foreign technology partners. This will prevent those who take advantage of lack of system of information sharing amongst leading institutions to borrow large amount against same assets and property, which has in no measures contributed to the incremental of NPAs of banks.

49 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

50 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

SUGGESTIONS TO CONTROL NPAs:

The Bank should adopt the following general strategies to control NPAs. The suggestions are as follows: Projects with old technology should not be considered for finance Large exposure on big corporate or single project should be avoided. Operating staffs credit skills should be up graduation. There is need to shift banks approach from collateral security to viability of the project and intrinsic strength of promoters. Timely sanction and or release of loans by the bank is to avoid time and cost overruns. Bank should prevent diversion of funds by the promoters. Operating staff should scrutinize the level of inventories/receivables at the time of assessment of working capital. The Credit section should carefully watch the warning signals viz. non-payment of quarterly interest, dishonor of check etc. Effective inspection system should be implemented. Identifying reasons for turning of each account of a branch into NPA is the most important factor for upgrading the asset quality, as that would help initiate suitable steps to upgrade the accounts. The bank must focus on recovery from those borrows who have the capacity to repay but are not repaying initiation of coercive action a few such borrows may help. The recovery machinery of the bank has to be stream lined; targets should be fixed for field officers / supervisors not only for recovery in general but also in terms of upgrading number of existing NPAs. In the bank there should be a proper manpower planning. Bank should try to establish the branches in competitive market, so it will increase their profit. Bank has required increasing the cash and bank balances byreducing the unnecessary expenses for future plan

51 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

CONCLUSION:
Growing NPAs is one of the biggest problems that the private Indian banks are facing today. If proper management of the NPAs is not undertaken it would hamper the efficiency of the banks. If the concept of NPAs is taken very lightly it would be dangerous for the banking sector. The NPAs destroy the current profit and interest income and affect the smooth functioning of the recycling of the funds. Banks also redistribute losses to other borrowers by charging higher interest rates. Lower deposit rates and higher lending rates repress savings and financial markets, which in turn hampers the economic growth of the country. Thus, it is highly essential for the banks to focus their attention on growth of NPAs and take appropriate measures to regulate their growth.

52 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

BIBLIOGRAPHY: Nelson M. Waweru et.al (2009), Global Journal of Finance and Banking Issues Volume 3, No. 3 2009 Kevin Greenidge et.al (2010), Forecasting non-performing loans in Barbados, 80 / business, finance & economics in emerging economies vol. 5 no. 1 2010 Gorter, N. & Bloem M., (2002), the macroeconomic statistical treatment of NPLs, Publication of the Organization for Economic Corporation & Development Brownbridge, M., (1998) the Causes of Financial Distress in Local Banks in Africa and Implications for Prudential Policy M. Karunakar et.al (2008), Are non - Performing Assets Gloomy or Greedy from Indian Perspective, Research Journal of Social Sciences, 3: 4-12, 2008 Bloem, A.M., & Goerter, C.N (2001), The Macroeconomic Statistical Treatment of NonPerforming loans, Discussion Paper, Statistics Department of the IMF, Decembere1, 2001 Das, A., & Ghosh, S (2003), Determinants of Credit Risk, Paper presented at the Conference on Money, Risk and Investment held at Nottingham Trent University, November 2003. Anurag, 2007, Causes for Non Performing Assets in Public Sector Banks, [Online] Available at: http://www.123eng.com/forum/viewtopic.php?p=14590.
G.V.K. Kasthuri, 2009. Basel Norms for Indian Banks, [Online] Available at: http://gvkk.blogspot.com Management and resolution of NPAs legal and regulatory regime, [Online] Available at: http:// www.mbaknol.com

R P Balakrishnan, Opportunities opened by Basel II, [Online] Available at: http://www.chillibreeze.com

53 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

BOOKS:
1) Marketing Research- An Applied Orientation by Naresh K. Malhotra; Edition-Fourth; Publication-New Delhi

WEBSITES:
1) http://rbi.org.in/scripts/AnnualPublications.aspx?head=Trend and Progress of Banking in India 2) http://rbi.org.in/scripts/AnnualPublications.aspx?head=Statistical Tables Relating to Banks of India 3) http://rbi.org.in/scripts/NotificationUser.aspx 4) http://en.wikipedia.org/wiki/Banking_in_India 5) http://www.ibef.org/industry/Banking.aspx 6) http://www.bankingindiaupdate.com/general.html

54 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

ANNEXURE
Descriptive Statistics of Factors affecting NPAs:
Mean Factors Standard Deviation Factor Loading Communality Variance Cronbach Explained s Alpha (%) 28.79 .721

F1 Recession and management failure 3.15 Recession in economy 3.00 Management Failure 28.39 F2 Execution Problems 2.92 Improper Credit Appraisal Difficulty in executing Repayment procedure Cost of effective legal measures 3.46 2.46 1.115 .967 1.391 .850 .827 .730 .762 .713 .694 23.62 F3 Default by customers 2.77 Willful Default 2.15 Absence of Security 1.281 .854 .960 1.235 .914 .927 .753 .709 1.780 .837 .710 .987 .940 .891

55 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

Descriptive Statistics of Recovery Mechanisms adopted to reduce NPAs:

Mean Factors F1 Banking Measures Self involvement Recovery campus F2 Legal Measures Lok adalats SARFASI Act 2.31 1.85 1.494 1.214 .932 .891 .892 .874 2.08 2.00 1.256 1.414 .960 .951 .923 .910 41.71 .793 Standard Deviation Factor Loading Communality Variance Cronbach Explained s Alpha (%) 48.25 .912

Factorial profile of recovery mechanism for NPA by banks

No. of No. of rounds factors 1 2 3 3 Communalities Iterations KMO Items (Above) (Above) Deleted .60 .65 4 5 .45 .34 1 Items V.E Remained % 8 7 80.36 80.81 Factor Loading (Above) .55 .70

One-Sample Test Test Value = 2 95% Confidence Interval of the Difference t VAR00002 .222 df 12 Sig. (2-tailed) .828 Mean Difference .05769 Lower -.5081 Upper .6235

56 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

One-Sample Statistics N BART factor score 4 for analysis 2 BART factor score 1 for analysis 3 13 Mean 2.0385 Std. Deviation 1.28228 Std. Error Mean .35564

13

2.0769

1.23905

.34365

KMO and Bartlett's Test Kaiser-Meyer-Olkin Measure of Sampling Adequacy. Bartlett's Test of Sphericity Approx. Chi-Square df Sig. .505 20.921 6 .002

Total Variance Explained Rotation Sums of Squared Initial Eigenvalues Extraction Sums of Squared Loadings Loadings % of Compon ent 1 2 3 4 Total 2.044 1.555 .253 .148 % of Variance 51.097 38.873 6.327 3.703 Cumulativ e% 51.097 89.970 96.297 100.000 Total 2.044 1.555 % of Variance 51.097 38.873 Cumulative % 51.097 89.970 Total Varian Cumula ce tive %

1.930 48.251 48.251 1.669 41.719 89.970

Extraction Method: Principal Component Analysis.

57 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

A study of non-performing assets in Indian private banking sector

We are pursuing MBA and we are conducting a study on non performing assets in private banks. Please answer the questions below. Your response in this regards is very valuable for the success of our project. Also note that the information so revealed will be utilized without directly disclosing the identity of the concern Bank/Officials.
Name Designation .... Branch

Since how long the branch is functioning 2-3yrs 3-5yrs 0-2yrs Since how long the presence of NPA is observed in your branch
0-1yrs 1-2yrs 2-3yrs

5yrs above

5yrs

What is the approximate value of NPA in your branch? (Rs in lakhs)

1-10 10-20 20-30 above- 40

For which category the NPA is being observed

Personal loan Housing loan vehicle loan Agri-term loan

58 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

The main reasons for NPAs in the bank

(Rating factors 1-5 according to the importance of factor. 1- Most effective, 2- effective, 3moderate, 4- non effective, 5- least effective.)

Factors
Improper credit appraisal Lack of effective follow up Diversion of funds willful default difficulty in execution of discredit cost of effective legal measures Absence of security Management failure demand recession

Measures for recovery of NPA adopted by the bank

Legal measures Both legal and non-legal non legal measures other then specify

Which of the following recovery mechanism are adopted by the bank for NPA?
(Rating factors 1-5 according to the importance of factor. 1- Most effective, 2- effective, 3moderate, 4- non effective, 5- least effective.)

Factors
Lok adalats Civil courts Corporate and restructuring Self involvement debt recovery tribunal one time settlement scheme recovery campus SARFAESI Act.

59 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks

To what extent your bank has been succeeded in converting NPA into good assets?
1% 2% 3% 4% 5% >5%

Has the profitability improved after adopting reduction technique?

Definitely improved Cant say improved definitely not improved

Thanks for your co-operation.

60 CAPSTONE PROJECT A study of Non Performing Assets on Indian Private Banks