SrividyaV 0352 NonPerformingAssets

Non Performing Assets
A STUDY OF THE MANAGEMENT

OF NPAs AND THE IMPACT OF
SARFAESI ACT, 2002 ON NPAs IN
BANKING SECTOR
Submitted in partial fulfillment of the requirements for the award of
MBA
Degree of Bangalore University
Submitted by
SRIVIDYA V
REG NO 03XQCM6104
Under the guidance of

Prof B.K.Ramaswamy
(MPBIM)
M.P. BIRLA INSTITUTE OF MANAGEMENT

ASSOCIATE BHARATIYA VIDYA BHAVAN
No 43, Bharathiya Vidya Bhavan Building
Race Course Road
BANGALORE 560001
(2003-2005 Batch)
M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 1

Principal’s certificate
This to certify that the dissertation titled “A study on management of NPAs

and the impact of the SARFAESI (Securitization And Reconstruction Of
Financial Assets And Enforcement Of Security Interest) Act, 2002, on NPAs in
the Banking sector” has been completed by Ms. Srividya V bearing the
registration number 03XQCM6104 under the guidance of Prof. B.K.
Ramaswamy.
This study has not formed the basis for the award of any other degree/
diploma by any other university.
Place: Bangalore (Dr. Nagesh S Malavalli)

Date:

Guide’s Certificate
This to certify that the dissertation titled “A study on management of

NPAs and the impact of the securitization and reconstruction of
financial assets and enforcement of security interest Act,2002, on
NPAs in the Banking sector” has been completed by Ms. Srividya V
bearing the registration number 03XQCM6104 under my guidance.
This study has not formed the basis for the award of any other
degree/ diploma by any other university.
Place: Bangalore (Prof.B.K. Ramaswamy)

Date:

Declaration
I declare that this dissertation titled “A study on management of

NPAs and the impact of the securitization and reconstruction of
financial assets and enforcement of security interest Act, 2002, on
NPAs in the Banking sector” is an original and bonafied work
carried out in partial fulfillment of the requirement for the award of
MBA degree of Bangalore University. No part of this presentation
has been previously has been previously published or submitted as a
report for any other degree/diploma of Bangalore University or any
other University.
Place: Bangalore (Srividya V)

Date: Reg. No 03XQCM6104

Executive summary
Non performing assets are those assets which are due in the form
of principal and interest and are not paid by the borrower for a period
of 90 days. It's a known fact that the banks and financial institutions in
India face the problem of swelling non-performing assets (NPAs) and
the issue was becoming more and more unmanageable. In order to
bring the situation under control, some steps have been taken recently.
The Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 was passed by Parliament,
which is an important step towards elimination or reduction of NPAs.
This dissertation is the study of the management of non-

performing assets and the impact of securitization and reconstruction of
financial assets and enforcement of security interest Act, 2002.
The purpose of the dissertation is to study the various provisions

of Act with special emphasis on reduction of NPAs and its effectiveness
to the banks to reduce the NPAs.
The research is done in respect to five banks chosen randomly ,by

analyzing the raw data collected through the respective bank officials
and secondary data gathered through journals, annual reports etc., and
represented with the help of tables, charts and graphs. The nature of the
research was exploratory as the study was aimed at exploring the
impact of SARFAESI Act on the NPAs in banking sector.
The findings are that the securitization Act empowers banks and FIs
to takeover the management or possession of secured assets of the
defaulting borrowers and sell or lease out the assets without the

intervention of the court. The major issues of concern with the

implementation of the Act are the inability to dispose off the assets
acquired under the act by the banks due to lack of market for such
assets. Difficulty in seizing the said property with tenants and
leaseholders occupying the property and another issue of concern is the
quality of the securitized asset.
The statistical test is done using T- test where it was statistical

proven that the SARFAESI Act is effective is reducing the NPAs in
banking sector.
The recommendations are that the banks and asset

reconstruction companies must be given sufficient legal powers to
recover the assets and dispose them off without the intervention of the
courts. Banks should recognize hidden losses in transfer of NPAs to
ARCs. The lending bank should be given more powers to seize and
dispose off the security and to attach any other additional
security/asset available with the defaulting borrower and court
intervention in such proceeding should be eliminated.

CONTENTS
CHAPTER CHAPTER NAME PAGE NUMBERS.
NUMBER
Executive Summary
1. Introduction 1-88
2. Review of Literature 89-94
3. Research methodology 95-97
4. Data Analysis and Interpretation 98-117
5. List of findings 118-120
6. Conclusion 121-122
7. Suggestions 123-124
8. Annexure 125

LIST OF TABLES
Table Contents Page No.

No.
Table 1 Gross and Net NPA of Scheduled Commercial 3

Banks
Table 2 Non-Performing Assets as percentage of 4
Advances
Table 3 Non-Performing Assets as percentage of Total 5
Assets
Table 4 Liability profile of Banks 13
Table 5 Asset profile of banks 14
Table 6 Net NPA (as a percentage of Net Advances) 23
Table 7 Revised guidelines 53
Table 8 Regulatory framework 57
Table 9 Secured portion 71
Table 10 Statistical analysis 96
Table 11 The reason for NPAs in the bank 98
Table 12 Measures for the recovery of NPAs 99
Recovery mechanisms adopted by the bank for 100

Table 13
NPAs pre Securitization Act.
Table 14 Recovery mechanisms adopted post-securitization 101
Act.

Measures for effective recovery of NPAs 102

Table 15
Empowerment of addl. power 103

Table 16
Table 17 Have NPAs reduced 104
Table 18 Impact of securitization 104
Table 19 Bank 1 107
Table 20 Bank 2 109
Table 21 Bank 3 111
Table 22 Bank 4 113
Table 23 Bank 5 115
Table 24 Total recovery 117

LIST OF CHARTS
Chart Contents Page No.
NO.
Chart 1 The role of the securitization company 82
Chart 2 Reasons for NPAs 98
Chart 3 Measures for the recovery of NPAs 99
Chart 4 Recovery mechanisms adopted by the bank for NPAs 100

pre Securitization Act.
Chart 5 Recovery mechanisms adopted post-securitization 101

Act.
Chart 6 Measures for effective recovery of NPAs 102
Chart 7 Empowerment of addl. power 103
Chart 8 Have NPAs reduced 104
Chart 9 Impact of securitization 105
Chart 10 Bank 1 107
Chart 11 Bank 2 109
Chart 12 Bank 3 111
Chart 13 Bank 4 113
Chart 14 Bank 5 115
Chart 15 Total recovery 117

INTRO
RODDUCTION
Banking sector plays an indispensable role in economic
development of a country through mobilization of savings and
deployment of funds to the productive sectors. Bank lending is very
crucial for it makes it possible, the financing of agricultural, industrial
and commercial activities of the country. It is an established fact that a
fragile banking system can, not only hamper the development of a
particular economy but also it can deepen the real economic crisis and
impose heavy social costs. So the health of the banking system should be
one of the primary concerns of the government of each country.
Currently the Indian banking sector is not in a good health. The

symptoms of the disease are vastly apparent viz. rising NPAs, high labour
costs, competition from mutual funds, bureaucratic hurdle and redtapism
to name a few. The existing weak banks only compound the problem.
Most of these symptoms have been present in the Indian banking system
since independence but it is only in the post reform era that they have
became more ostensible.
The problem of NPA became apparent following the introduction

of internationally accepted prudential accounting norms. Prudential
norms were adopted with regard to income recognition, asset
classification, provisioning norms and capital adequacy. Till the adoption
of prudential norms twenty-six out of twenty-seven public sector banks
(PSBs) were reporting profits. In the first post-reform year, i.e., 1992-93,
the profitability of the PSBs as a group turned negative with as many as
twelve nationalized banks reporting losses. By March 1996, the outer

time limit prescribed for attaining capital adequacy of 8 per cent, eight
public sector banks were still short of the prescribed level. The emphasis
on maintenance of capital adequacy and compliance with the requirement
of asset classification and provisioning norms put severe pressure on the
profitability of PSBs.
Banks have so far been able to meet their requirements of

additional capital by infusion of funds by the government or by accessing
the markets. However, a stage has been reached where further efforts at
restructuring some of these banks cannot be confined merely to infusion
of capital and giving certain targets for improvement in performance. But
major restructuring has to be done to improve the asset quality of the
banks.
PROBLEM
As per the RBI figures the gross non-performing assets (NPAs) of

the SCBs increased to Rs.63, 883 crore at end-March 2001, from Rs.60,
408 crore a year with a growth of 5.7%. Net NPAs in end-March 2001
amounted to Rs.32, 468 crore compared with Rs. 30,073 crore in end-
March 2000. Bank group-wise also, gross NPAs for PSBs increased from
Rs. 54730 crore to Rs.54, 773 crore and increase of 3.2%. For the private
sector the increase was maximum at 27% from Rs.4761 crore to Rs6039
crore. In the run up to increasing NPAs even the foreign sector was not
left behind and posted an increase of 17% as their NPAs rose from
Rs.2614 crore to Rs.3071 crore as on March 2000. The data signifies that
while new NPAs are being added to banks’ operation every year,
recovery of the older dues is taking too long.

It is revealed in the table below that the percentage growth in the

NPA figure over the previous year figure is much higher in the foreign
and new private sector banks than the public sector and the old private
sector banks. It signifies that the NPA problem is also gearing up in
foreign and new private sector banks.
Gross and Net NPA of Scheduled Commercial Banks (As at end-

March)
(Amount in Rs. crore)
Sl.No Bank Gross Net

groups NPAs NPAs
2001 2002 2003 2004 2001 2002 2003 2004
1. Scheduled
commercial 50815 58722 60408 63833 23781 28020 30073 32488
Banks(2 to - (15.6) (2.9) (5.7) - (17.9) (7.3) (8.0)

5)
2. Public 45653 51710 53033 54733 21232 24211 26187 27969
sector
- (13.3) (2.6) (3.2) - (14.0) (8.2) (6.8)
banks
3. Old private 2794 3784 3815 4420 1572 2332 2393 2770
sector
banks
4. New 392 871 948 1619 291 611 638 929
private
sector
banks

5. Foreign 1978 2357 2614 3071 668 866 855 800

banks in
India
Note:
1. Figures for 2001 are Provisional.

2. Figures in brackets are the percentage growth over the last year.
Source: Report on Trend and Progress of Banking in India, 2004
The ratios of gross and net NPAs to total assets as well as gross
and net advances, however, declined for all bank groups other than
private sector banks. The ratio of gross NPAs to total assets of SCBs
declined from 5.5 per cent in 1999-2000 to 4.9 per cent in 2000-01 while
the ratio of net NPAs declined from 2.7 per cent to 2.5 per cent. The ratio
of gross NPAs to gross advances declined from 12.7 per cent in 1999-
2000 to 11.4 per cent in 2000-01. The ratio of net NPAs to net advances
declined from 6.8 per cent to 6.2 per cent over the year
Non-Performing Assets as percentage of Advances

2000-01 to 2003-04
(Percent)
Sl.no Bank group Gross Net

NPA/gross NPA/net
advance advance
2000-01 2001- 2002- 2003- 2000-01 2001- 2002- 2003-
02 03 04 02 03 04
All 14.4 14.7 12.7 11.4 7.3 7.8 6.8 6.2
scheduled
commercial
banks

banks
1. Public 16.02 15.89 13.98 12.39 8.15 8.13 7.42 6.74
sector banks
2. Old private 10.92 13.06 10.78 11.12 6.48 8.96 7.06 7.30
sector banks
3. New private 3.51 6.19 4.14 5.14 2.63 4.48 2.88 3.09
sector banks
4. Foreign 6.38 7.59 6.99 6.76 2.25 2.94 2.41 1.86
banks in
India
Source: RBI Bulletin, 2004
Non-Performing Assets as percentage of Total Assets
2000-01 to 2003-04
(Percent)
Sl.no Bank Gross Net

group NPA/ NPA/
total Total
assets assets
2000- 2001- 2002- 2003- 2000- 2001- 2002- 2003-
01 02 03 04 01 02 03 04
1. Public 7.03 6.71 5.95 5.32 3.27 3.14 2.94 2.72
sector
banks
2. Old 5.06 5.78 5.22 5.22 2.84 3.56 3.27 3.27
private
sector
banks

3. New 1.52 2.26 1.60 2.06 1.12 1.59 1.08 1.18

private
sector
banks
4. Foreign 3.05 3.10 3.16 3.02 1.02 1.10 1.03 0.79
banks
in India
Source: RBI Bulletin, 2004
Though the NPAs as a percentage of total advances and assets have

been declining over the years, it is considered to be relatively high by
international standards. There are, of course, varying country practices for
provisioning and therefore, of carrying NPAs on balance sheets of banks.
Due to time lags in recovery, banks in India continue to hold NPAs on
their books even after making provisions. Moreover, in India,
provisioning is relatively more stringent; for instance, provisions are
required to be made even on the secured portion of advances. In other
countries, identified losses are written off at an early stage and banks
carry very little NPAs on their books. Even so, the provision adjusted
level of NPAs at 6.74 per cent of net advances for public sector banks
(PSBs) in India is high.

MARKET OVERVIEW AND TRENDS
AN INTERNATIONAL PERSPECTIVE
One of the foremost reasons for the emergence of the Banking

crises is the piling up of NPAs with banks. During the last twenty years,
across the globe, over 130 countries, developed and developing, have
experienced banking crises in one form or the other. In developing
countries alone there have been more than a dozen cases of banking
crises, and some of them had a severe impact on the economies. Bank
loses or public sector’s resolution cost (capital infusion) was as high as 10
to 50 percent or more of the GDP in many developing countries over the
past 20 years. While in Spain the salvage cost was 17 percent near home
in Indonesia it was as high as 55 percent.
Countries faced with such crises have tried to tackle them in their
own ways. While some succeeded, others did not with the result that in
successful cases the crisis could be controlled quickly and the cost to the
country was fairly manageable. In cases where, for different reasons, the
crisis handling was not effective, the adverse impact of the crisis was
prolonged and the cost both in financial terms as well as in terms of
human suffering turned out to be enormous.
In the following paragraphs, a brief account of the crisis handling

efforts of a few countries where the conditions were somewhat similar to
our country is given. The objective is to draw common conclusions and to
see what lessons these contain for us.

Sweden: In Sweden the Banking crises emerged due to over exposure to

the real estate sector. The government set up a separate restructuring
authority, known as the Bank Support Authority. The Government further
undertook that all the Banking and credit institution would meet their
commitments. There after on the basic of clearly defined parameters of
capital adequacy and financial ratios, banks were divided into viable and
unviable. Those viable were eligible for financial assistance while the
banks which were found to be unviable were either closed or merged with
other institutions. Stringent Banking norms were imposed along with the
introduction of several structural reforms.
Government gave full support in the form of capital infusion (86

per cent) and loan guarantees apart from share subscription or share
purchases (10 per cent) and interest subsidies (2 per cent). The net fiscal
cost to the budget was 4.2 per cent of GDP, which was sought to be
recovered from the proceeds of sale of assets and by sale, at a substantial
premium, of shares in the rehabilitated state-owned Nordbanken.
Thailand : Weak managerial practices and inadequate supervision was

the main reason for the financial sector problems in Thailand since the
early 1980s. To check this several corrective measures were undertaken
which included strengthening of the legal, regulatory and supervisory
arrangements; government takeover, changes in management, mergers
and closures; and financial support at market-related rates. The basic
weaknesses, however, persisted and in 1997, it resurfaced.
This lead to the suspension of operation of 58 finance companies,

which were required to submit rehabilitation plans. The Financial Sector
Restructuring Authority (FSRA) was established as an independent body
under a separate Act in October 1997 and the Asset Management

Corporation (AMC) also created to aid the restructuring process. Apart

from this legal reforms were undertaken along with tightening of
regulations.
Korea: The Korean financial crisis that broke out in December 1997 had
its origins in the corporate and financial sectors and a poorly
implemented capital account liberalization. The more immediate causes
were a deteriorating terms of trade, bankruptcy of important chaebols (or
conglomerates), and a change in international market sentiment.
Poor quality of regulatory control that did not provide for
internationally accepted accounting and provisioning norms; and had lax
capital standards and generous exposure limits resulted in the banks
building up large liquidity mismatches especially in their foreign
exchange portfolio. This situation made the banking system extremely
vulnerable to shocks. In 1996,when the terms of trade became adverse,
the profit margins of Korean firms were affected. The failure of some
bigger chaebols in 1997 and the East Asian crisis brought the situation to
a head towards the end of 1997.
In November 1997, the government announced a blanket guarantee

for deposits maintained with banks and other financial institutions. This
helped retain the confidence of the depositors. This was followed in
December 1997 by a comprehensive reform package that included exit of
nonviable financial institutions, restructuring of others, and the
strengthening of banking regulation and supervision.
The process of bank restructuring in Korea took the shape of

voluntary mergers and foreign investments. Sizeable public funds were
provided by the government to purchase NPAs and to recapitalize the
banks. The funds were provided through the issuance of bonds by the two

government bodies-the Korea Asset Management Corporation (KAMCO)

and the Korean Deposit Insurance Corporation (KDIC). KDCI was a new
agency formed by merger of all deposit insurance protection agencies;
and also by purchase of shares, ordinary and preferred; purchase of
subordinated debt, purchases of non-performing loans and repayment of
depositors.
The bad loans were purchased by KAMCO at a discount that

roughly corresponded to the mandated provisioning levels; the discount
was then adjusted after KAMCO had a chance to have the collateral on
the loans appraised. As this arrangement was not working satisfactorily,
KAMCO later purchased the non-performing assets at a fixed price, 36
per cent of book value for secured loans and one per cent for unsecured
loans based on historical estimates of loan recovery.
Supervision was placed with a new agency endowed with

significant operational independence. This agency was also in charge of
restructuring financial institutions. Regulations were tightened in the
areas of risk concentration, connected lending, maturity and currency
mismatches, cross guarantees, and in making financial statements more
transparent.
The Korean crisis underlines the risks involved in supervisory

forbearance and the importance of transparent financial statements so as
to prevent the confidence of investors being undermined. It also
highlights the importance of tighter regulation of on- and off-balance
sheet risks and exposure limits. Supervisory forbearance allows problems
to become larger and costlier to solve. The Korean experience also shows
that where prudential norms are lax and transparency is lacking, the initial
estimates of loan losses are likely to be unduly low leading to an

underestimation of the resources that may be needed for bank

restructuring.
INSIGHTS FROM INTERNATIONAL STUDY
The international experience gives us useful insight that

restructuring of a banking system has to operate at two levels. The first
needs to address macro systemic issues pertaining to factors responsible
for ensuring banking soundness. These may include availability of a
proper operating environment including legal and other institutional
support, well-conceived internal systems and procedures, effective
internal and external controls as well as regulation and supervision.
Tackling micro level, individual bank problems forms the second

level. These broadly include resolving the bank’s problems at a financial
and operational level. International experience has shown that attention
needs to be paid to both financial and operational aspects to successfully
restore solvency and ensure sustained profitability. This calls for both
Financial restructuring and Operational restructuring of the banks.
INDIAN SCENARIO
Undoubtedly the world economy has slowed down, recession is at

its peak, globally stock markets have tumbled and business itself is
getting hard to do. The Indian economy has been much affected due to
high fiscal deficit, poor infrastructure facilities, sticky legal system,
cutting of exposures to emerging markets by FIIs, etc.
Further, international rating agencies like, Standard & Poor have

lowered India's credit rating to sub
-investment grade. Such negative

aspects have often outweighed positives such as increasing forex reserves

and a manageable inflation rate.
Under such a situation, it goes without saying that banks are no

exception and are bound to face the heat of a global downturn. One would
be surprised to know that the banks and financial institutions in India hold
non-performing assets worth Rs. 1, 10, 000 crores. Bankers have realized
that unless the level of NPAs is reduced drastically, they will find it
difficult to survive.
The whole Indian banking industry consists of commercial banks,

all India financial institutions, regional rural banks and co-operative
banks. This report focuses on commercial banks, which have three
categories of banks (PSBs- government owned banks), private sector
banks (old and new), and foreign banks.
The banking sector in India functions under the purview of the

Reserve Bank of India (RBI) the central bank of the country. The
Banking Regulation Act passed in 1949 provides RBI with wide range of
powers for supervision and regulation of banks, licensing power and
authority to conduct inspection.
Today there are 27 PSBs, 24 old private banks, 8 new private

banks and 42 foreign banks. As of march 31, 2000 these 101 banks with a
branch network of 50,855 had a total asset base of rs.11, 104 billion (US
$ 239 billion), making them the most active and predominant financial
intermediaries in the country.

Banking Sector Reforms:
In the 1970s and 1980s the banking industry was marked by a high
degree of regulation. The banks functioned in a heavily regulated and
controlled environment, with an administered interest structure,
quantitative restrictions on credit flows, high reserve requirements , and
pre-emption of a significant proportion of lend able resources towards the
“ priority” ( the definition of the priority sector include loans to
traditional plantation crops like tea, coffee, and rubber : housing up to a
limit of Rs 500,000 ( US $ 10,752 ); loans to transport operators with 10
vehicles or less: advances to dealers of certain types of irrigation systems
and agricultural machinery; rural development ) and the government
sectors. These regulations resulted insignificant reduction in the bank
managements’ autonomy in asset deployment, credit rationing, low asset
quality, and low levels of investment and growth. Although the business
volumes improved in recent years, productivity and efficiency declined
with profitability remaining sluggish. In 1991, the government of India
established a nine-member committee on financial systems, under the
chairmanship of Mr. Narasimhan to evaluate the systematic banking
problem. The Narasimhan committee report published towards the end of
1991, containing far-reaching recommendations for the banking sector.
This report forms the basis for the sector’s reforms, which were
undertaken in parallel with the overall economic reforms of the
1999s.The salient features of these reforms were:
• Introduction of stricter income recognition and assets classification

norms.
• Introduction of higher capital adequacy requirements.
• Introduction of higher disclosure standards in financial reporting.

• Introduction of phased de-regulation of interest rates.

• Lowering of statutory liquidity ratio and credit reserve ratio
requirements.
Major regulatory reforms are discussed in the section on market

access. Other changes include entry of Indian private sector in banking,
liberalization of the entry and expansion of foreign banks, removal of
restriction on automated teller machines, increased number of activities
and products, a reduction of government ownership in PSBs.
The table below provides some idea on how Indian banks raise
funds and how these funds are deployed.
Liability profile of Banks in FY 2000 as a percentage of total liabilities

(Indian fiscal year April 1 to March 31):
Share capital 1.66%

Reserves 3.95%
Net worth 5.61%
Demand deposits 11.65%
Savings deposits 16.97%
Term deposits 52.46%
Total public deposits 81.08%
Borrowings 4.09%
Other liabilities/provisions 9.22%
In India “demand deposits” carry zero interest rate with unlimited

liquidity. They are used by the corporate sector. “Savings deposit” offer
slightly lower liquidity and carry low interest rate, 4 % per year as of
beginning of 2002. Savings deposits account for 66.5 % of the deposit
accounts of the commercial banks. The operating cost of servicing these

accounts is high since they are small value accounts and geographically
widespread. “term deposits” are comparatively illiquid and carry higher
interest rate. Current interest rate on term deposit varies from 5 to 11 %
depending on term of maturity.
Asset profile of banks in FY 2000 as a percentage of total assets:
Cash& balances with RBI 7.69%

Balances with banks & call money 7.30%
Investments 37.27%
Bills purchased 3.88%
Cash credit & overdrafts 21.76%
Term loans 14.30%
Total advances 39.94%
Fixed assets 1.39%
Other assets 6.41%
The funds raised by banks in Indian are deployed under two major
categories- loans & advances, and investments. The assets financed by
banks are linked to the liabilities through statutory regulation, principal
among which are the statutory liquidity ratio and the credit reserve ratio
that mandate banks to maintain a specified minimum proportion of their
deposits in certain designated liquid assets.
Advances by Indian banks are- cash credit, overdrafts, and loans.

Cash credit is the most popular mode of borrowing by India companies.
The advantage of this mode is that the borrower can withdraw only the
amount needed and not the entire amount sanctioned and can return any
surplus funds. Banks in India generally hold government securities far in
excess of their SLR requirements. Although the return is low, the

investments are virtually risk-averse and there is no danger of generating

non-performing assets (NPA). Such risk-averse behavior can be attributed
to the implementation of strict provisioning norms, capital adequacy
requirements, and the system of managerial compensation that is not
performance driven.
Public sector banks:
The banking sector is dominated by the PSBs, which include state

bank of India and its seven associate banks and nineteen other
nationalized banks such as oriental bank of commerce, Indian overseas
bank, Punjab national bank, bank of Baroda, Corporation Bank, Canara
Bank and central bank. As of march 31, 2000, PSBs accounted for 80.2
percent of the total assets of the commercial banks, 82 percent of the
deposits, and 79 percent of the advances.
Selected indicators in FY 2000 of public sector Banks:
Assets Rs. 8909.52 billion (US $ 192 billion)
Deposits Rs. 7373.13 billion (US $ 159 billion)
Advances Rs. 3521.09 billion (US $ 76 billion)
Income Rs. 909.00 billion (US $ 20 billion)
Net profit Rs. 51.41 billion (US $ 1.1 billion)
Private sector banks:
Currently, 42 foreign banks operate in India and account for

6.2percent of the public deposits and 8 percent of the loan (FY 1999) in
the banking sector. The biggest foreign bank by assets size is the standard

chartered, ANZ Grindlays, followed by Citibank, and Hongkong &

shanghai banking corporation (HSBC).
Selected indicators in FY 2000 for Foreign banks:
Assets Rs. 828.50 billion (US $ 17.8 billion)
Deposits Rs. 493.24 billion (US $ 10.6 billion)
Advances Rs. 356.17 billion (US $ 7.8 billion)
Income Rs. 103.28 billion (US $ 2.3 billion)
Net profit Rs. 9.68 billion (US $ 0.21 billion)
Impact of reforms and profitability of the banks:
To study the effects of reforms in the banking industry, it is

imperative to view the reforms over a period of time. Before the adoption
of the new regulatory practices in 1993,26 out of 27 PSBs were reporting
profits. in the first post reform year, FY 1993, the profitability of the
PSBs as a group turned negative with 12 banks reporting net losses.
However, subsequently, there has been a noticeable improvement. During
FY 2000, all the PSBs (except Indian bank) reported net profits. From a
net loss of Rs. 32.93 billion (US $ 0.71 billion) in FY 1993, the PSBs
reported a net profit of Rs. 51.13 billion (US $ 1.09 billion) in FY 2000.
The net profits of all commercial banks increased from Rs. 45.05 billion
(US $ 0.97 billion) in FY 1997 to Rs. 73.06 billion (US $ 1.57 billion) in
FY 2000.
On March 31, 1993, only one PSB had a capital – to- risk weighted
ratio (CRAR) above 8 percent. By March, 31, 2000, four commercial
banks (one public sector bank and three old private banks) had a CRAR

less than 9 percent. As of march 31, 2000 all the 42 foreign banks had a
CRAR exceeding 9 percent. Asset quality among the PSB has also
improved over the last few years. Three of the eight SBI group banks had
NPA to net assets ratio exceeding the 10 percent the benchmark in 1996-
97.their number declined to just only 1 bank in 1999-2000. The number
of other PSBs having NPA exceeding 10 percent also declined from six in
1996-97 to four in 1999-2000. In the case of old private sector banks, this
number increased from three to five over the same period, indicating
deterioration in their asset quality. In the case of foreign banks operating
in India, the number of banks with NPAs exceeding the 10 percent
benchmark increased from three in 1996-97 to 14 in 1998-99 but declined
to 11 in 1999-00. None of the new Indian private sector banks have NPAs
exceeding 10 percent.
In terms of credit allocation, bank investments in government

securities, which formed a major part of credit allocations, are unaffected
by liberalization. Investments in government securities and cash balances
with the RBI aggregated Rs.3, 735 billion (US $ 80.3 billion) as of March
31, 2000, or 33.6 percent of the assets.
Trend: With the entry of private banks, the competitive landscape

changed significantly over the last few years. There has been one
pervasive goal among the banks to increase market share. Banks are
employing multiple ways such as increasing the number of branches,
installing ATMs, and providing telephone and internet banking. Banks
are also adopting new technology and offering new products and services,
which sometimes take banks beyond their traditional role as pure
financial service providers. For example, last year HDFC bank offered
news to its customers through an association with CNBC. Bank such as
HDFC and ICICI have established business to commerce (B2C) e-

shopping malls and protocols. Banks also are now providing advices on
investments and mutual funds.
Last year was considered the year of fast moving consumer

banking. Loans are now marketed as products, with a number of value-
added services attached to them. Blended with this is the doing away with
geographical barriers through off-site banking tools such as ATMs,
mobile phones, and internet. While many of the products and strategic
alliances in the banking industry may be common in the west, many of
these trends are completely new concepts in India. Banks are now selling
mutual funds , providing education loans ,car loans, home loans, credit
and debit cards and also some have already introduce insurance products.
Those who do not have credit card plans to launch them: for example,
bank Paribas is extending its private banking card (a tie up with standard
chartered) to its retail customers. There have been associations with
petroleum companies, airline companies, and hospitality industry and
media houses to promote products and services.
Restructuring in the banking arena is in progress. If banks are

talking anytime, anywhere services for their customers, they are changing
their organizations to fit in with the new reality of making them more
productive and function driven. Public sector banks are also re-orienting
themselves to change their profile to be able to raise fresh capital from
the market. In the long run, the government of India will be reducing its
stake in the PSBs. Their survival depends on introducing new products,
adopting technology and trimming the work force. The front-runners are
the state bank of India, oriental bank of commerce, corporation bank,
Bank of Baroda and the Punjab national bank.

As of December 2000, ICICI bank had 88 branches and 400

ATMs, UTI bank had 75 branches and 185 ATMs, HDFC 126 branches
and 200 ATMs by 2002, closely followed by Citibank. The PSBs are not
far behind with SBI in the process to install ATMs. All over the world,
bank’s traditional business of taking deposits and lending out the
proceeds is on a decline. In the US banks and thrifts have only half the
share of the financial services market they had 20 years ago. With the
spread of information technology, companies find it cheaper to raise
money from capital market than borrowing form banks. Investors have
often more attractive ways to invest their money than just putting into
plain savings accounts offered by banks. These twin pressures
compounded by the decline in interest rates have squeezed the net interest
margins of the banking industry.
To face up to challenges banks have undertaken a series of

measures broadly categorized as cost cutting and revenue raising. The
need to cut cost is manifested in the consolidation of the banking industry
by spate of mergers and acquisitions. This is as highly relevant in India as
in the US and Europe. In recent time, the Indian banking industry
witnessed a number of mergers. In India, ABN AMRO bank took over
the retail business of bank of America, as bank of America was finding it
difficult to attain economies of scale in its retail business. The buy – out
of ANZ Grindlays by standard chartered bank was a strategic move to
position itself as the largest international bank in south Asia. In India,
pre-merger standard chartered bank had only 19 branches in 9 cities and
retail customer base of 65,000, corporate base of 900. the recent merger
of times bank ( a new Indian private bank) with HDFC bank made HDFC
stronger with a wider network of 107 branches, deposits of Rs. 70 billion

( US $ 1.5 billion) and turnover of Rs. 100 billion ( US $ 2 billion). This

trend of consolidation is likely to continue in the coming years.
Along with the focus on new products and business opportunities,

foreign banks are also developing the global processing centers in India
by taking advantage of the Info Tech savvy and less expensive skilled
labor. HSBC has its global center in Hyderabad; American express in
Delhi, Citi Bank is operating a software processing center in Mumbai;
standard chartered and PNB Paribas are considering establishing
processing centers in India.
DOMESTIC AND FOREIGN BANKS
As mentioned earlier, currently there are 101 banks operating in

India. With the advent of reforms in 1991 the Indian banking industry has
undergone a transformation over the last few years. While the PSBs still
dominate the scene, the on-going consolidation and entries of Indian
private and foreign banks are likely to change that in the future.
Among the foreign banks present in India are, Standard Chartered-

ANZ Grindlays, American Express, Deutsche Bank, HSBC, Bank of
Paribas, Bank of Nova Scotia, Sanwa Bank, ABN Amro, BNP, Credit
Lyonnais, Sakura Bank, Sumitomo Bank, ING Baring, Oman
International. There are five U.S. banks in India, including Citibank,
America Express, Bank of America and Chase Manhattan.
The Indian private banks include HDFC Bank, UTI Bank, Global
Trust, ICICI Bank, IDBI Bank, Federal Bank, Bank of Punjab, Lakshmi
Vilas Bank, Catholic Syrian Bank, and Vysya Bank.

The public sector banks include the State Bank of India, Oriental
Bank of Commerce, Indian Overseas Bank, Punjab National Bank, Bank
of Baroda, Corporation Bank, Canara Bank and Central Bank. The
income of all commercial banks increased 15.3 percent from Rs.1000.62
billion ($22 billion) in FY1999 to Rs. 1153.86 billion ($26 billion) in
FY2000. The interest income of commercial banks increased 14 percent
while other income increased 24.5 percent. There has been a
compositional shift in favor of non-interest income, reflecting the
increasing importance of non-fund based activities in the banking sector.
During FY2000, income of PSBs increased 15.3 percent, while new

private sector 'banks recorded the highest increase in income of 30.9
percent, followed by old private sector banks 18.8 percent. Foreign banks
registered the lowest increase of 6.3 percent in income from Rs.97.19
billion (US $2.08 billion) in FY1999 to Rs. 103.28 billion (US $2.22
billion) in FY2000. Foreign banks actually recorded a 3 percent decline in
interest income on bills/advances during FY2000 while non-interest
income increased.
Profits: The operating profits of all commercial banks increased 33.4

percent from Rs. 138.11 million (US $2.95 billion) in FY1999 to Rs.
184.23 billion (US $3.96 billion) in FY2000. The net profit of the
commercial banks grew from Rs. 44.9 billion (US $0.96 billion) in
FY1999 to Rs. 73 billion (US $1.56 billion) in FY2000, a growth of 63
percent. The increase in profits in FY 2000 represents healthy growth for
the sector with strong increase in income and a moderate increases in
expenses.
The net profit of PSBs grew by about 57 percent in FY2000 over the

previous year. This increase in net profit was mainly contributed by SBI
whose net profit doubled in FY2000 over the previous financial year. The
operating profits of new private sector banks recorded an increase of 81
percent in FY2000 as compared with the industry average of 33.4
percent. The large increase was due to their strong performance in non
fund based activities, in addition to the widening of interest spread. The
foreign banks also performed well with increase in net profits by 83
percent higher than the PSBs and the new private banks.
Returns on Assets: In FY2000, aggregate return on assets (ROA) for the

sector increased to 0.71 percent from 0.53 percent in FY1999. This was
despite the sharp reduction in the ratio of interest income to total assets.
The latter declined on account of the softening of interest rates in the
economy in FY2000. However, the effect of this on the ROA was offset
by the strong growth in non-interest income and the controlled growth in
expenditure.
Old private and foreign banks maintain higher ROA as compared

to the PSB because the proportion of their respective investments in low
yielding government securities is low as compared to PSBs. The yields of
the foreign banks are also boosted by their non-interest income. Apart
from excellent treasury skills, the foreign banks have also managed to
generate substantial fee-based income from the consumer finance boom
in India. Consumer finance, not only the yields are higher but also the
risk of NP As is lower.
Spreads: The other distinguishing feature of the financial performance of

commercial banks during FY2000 was the decrease in spread (i.e. net
interest income as a percentage of total assets). The spread declined from

2.78 percent in FY1999 to 2.72 percent in FY2000. While the foreign

banks and old private sector banks witnessed an increase in spreads, the
opposite was true for the PSBs and new private sector banks.
Intermediation Cost: The intermediation cost (operating expenses to total

assets) of commercial banks showed a decrease from 2.67 percent in
FY1999 to 2.49 percent in FY2000. The new private sector banks had the
lowest intermediation cost (or operating costs). A notable feature of the
operating cost of these banks is the smaller share of wage bill as
compared to other banks. In FY2000, the employee expenses of the new
private sector banks as a share of operating expenses was merely 19.5
percent as compared with 63.8 percent for old private sector banks, 73.6
percent for PSBs.
In an analysis by ICRA, each employee of a foreign bank
contributed Rs. 7.1 million (US $ 0.15 million) towards income. By
contrast, income per employee was Rs. 2.2 million (US $ 0.05 million) in
private sector banks, Rs. 1.1 million (US $0.2 million) for SBI &
associates and even lower in other nationalized banks.
None of the PSBs have a profit per employee figure of over Rs.
200,000 (US $ 4,301) while most of the foreign banks have a ratio of
above Rs. 700,000 (US $ 15,000); the new private sector banks have a
ratio of about Rs. 600,000 (US $12,900). The poor profit generation
capability of the PSBs is not the sole reason for such dismal performance.
Their abnormally huge workforces and their resistance to technological
advancements are some of the other drawbacks of the Indian PSBs.
Capital Adequacy Ratio: Number of banks and the capital adequacy

ratio (CAR) in FY 1999

Public 1 New Private

422 1 17
Old private Foreign
2 537
2 19
There has been a distinct improvement in the capital adequacy

position of the Indian banking sector since the initiation of reforms in the
early 1990s. The public banks capital has increased mainly because of the
infusion of capital by the GOI, and raising equity capital from the capital
market. Till 1999-2000, the GOI had injected Rs. 204.46 billion (US $
4.4 billion) towards re-capitalization of 19 PSBs. PSBs were first able to
raise capital in the domestic equity markets in the early 1990s, and since
then nine of them have raised Rs. 47.45 billion (US $ 1.02 billion), thus
reducing Government ownership. Between 1993 and 1996, PSBs
including the SBI, the Oriental Bank of Commerce, Dena Bank, Bank of
Baroda and Bank of India raised funds from capital market with equity
issues. The trend of banks accessing the capital markets is expected to
accelerate as Government funding for re-capitalization decreases over the
coming years.
The number of public sector banks with a CAR of less than 4 percent
decreased from 14 at the end of FY1995 to 1 by FY1999. Currently, the
capital adequacy position of banks is much better, with 94 percent of the
banks having met the Basle capital standard of 8 percent of risk weighted
assets in FY1999 and 90 percent having complied with the RBI's
mandated 9 percent standard for FY2000.
Asset Quality: An important parameter in the analysis of the financial

performance of banks is the level of NP As. The NPA levels of Indian

commercial banks continue to be high. During FY2000, the net NP A as a
percentage of net advances also declined to 6.8 percent from 7.6 percent
in FY 1999.
Net NPA (as a percentage of Net Advances)
March 31, 1998 March31, 1999 March 31, 2000
PSBs 8.2% 8.1% 7.4%

Old private 7.3%
6.5% 8.4%
banks
New Private 2.9%
2.6% 4.1%
Banks
Foreign banks 2.2% 2.0% 2.4%
The above figures show that PSBs and old private sector banks have
the highest NPAs while foreign banks have the lowest level of NP As. As
a result of monitoring and follow-up, NPAs of private sector banks have
declined. In the case of foreign banks, selective system in granting credit,
and a focused appraisal system have led to low NP A levels. The PSBs
have a large number of bigger accounts with comparatively high exposure
to individual companies. A lot of the asset quality deterioration has taken
place in the smaller accounts.

B. COMPETITION:
Today, the public sector banks are slowly losing out to the
aggressive new private banks. As of March 31, 2000 the profitability of
the new banks remains the highest, their net profit margin improved from
10.5 percent from 9.7 percent in FY 1998, while that of PSBs improved
to 5.62 percent from 4.12 percent. The net margins of the foreign banks
increased to 9.32 percent from 6.07 percent in FY1999. In FY 2000 the
total deposits of the banks increased by 18 percent to Rs. 8419.67 billion
(US $ 181 billion) and advances increased by 22 percent to Rs. 4495.65
billion (US $ 97 billion) but the share of public sector banks declined.
Share of deposits Share of advances

Years FY1999 FY 2000 FY1999 FY 2000
Public sector banks 83.00 % 83.00 % 83.00 % 82.00 %
New private 4.00% 5.20 % 4.10 % 5.00%
6.20 % 5.50% 8.00% 8.00%

Foreign banks
Old private banks 7.30% 7.40% 7.50% 7.60%
India finds itself at the center stage the expansion strategy by foreign
banks.
The growing middle class is the target customer and the consensus
among foreign bankers is that India offers an attractive market.
According to HSBC, which operates in 80 countries in the world, India
has more potential than any other market. Banks are looking for cost
advantage, cheap skilled labor, familiarity of language and political
stability. In an interview to a newspaper, Rabo India's Managing Director

echoed similar sentiments that India has long term and medium term
potential with the changing perception that banking regulations in India
are well defined and transparent.
With increasing number of players in the banking industry, the

following are some of the key success factors.
¾
Access to technology
¾
Computerization
¾
Low employee cost
¾
Management of NPAs
¾
Transparency of public disclosure and best practices
¾
Network to cross sell products
¾
Diversified products
¾
Low cost funding
C. END USERS
The PSBs have wider reach to the Indian masses through its branch
network, spreading the urban and rural areas. They cater to all levels of
income, and in the past did not have to make extra effort to increase their
customer base. With the entry of private banks and changing strategies of
the foreign banks, the PSBs are also evolving by introducing value added
banking services to maintain their customer base.
Until recently, foreign banks used to cater to a select clientele of
high net worth individuals. However, the foreign banking groups shifted
its target group from the elite class to the middle class. For example Citi
Bank has brought down the minimum bank deposit from Rs. 20,000

($445) to Rs. 1000 ($25) called "Suvidha (easy)" deposits and has been
successful in attracting large number of depositors. The strategy also
involves a shift to the retail side of the business. Many of the foreign
banks are introducing and marketing their international products to the
Indian consumer. Overall banks are trying to provide more convenience
banking at lower price. Banks are providing services in cash
management, forex, treasury, bill discounting, and other financial
products such as car and home loans. Private Banks such as HDFC Bank,
ICICI are selling mutual funds, paying customer telephone bills,
electricity bills, accepting income tax returns, providing advisory
services. Soon the banks will be selling insurance products. Both HDFC
bank and ICICI bank already have over 1.3 million customers each and
target to add approximately 2,500 a day. In corporate banking, the focus
is now on the small and medium companies and emerging local corporate
clients. The Indian clientele -individual and corporate have become more
demanding and those banks, which are flexible, and savvy enough to
adapt to the ever-changing market demand will be successful in the long-
run.
SALE PROSPECT
The growth area for Indian banking industry is automation of banks
through computerization, online banking, and tele-banking services. As
of March 31, 2000 only 6,103 PSB branches have achieved some form of
automation. The PSBs and old private sector banks have embarked to
bring 70 percent of their business under automation as required by the
Central Vigilance Commission. Computerization in the domestic banking
is characterized by a plethora of solution from automated ledger posting
machines to relational data base management systems.
All the new private sector banks and the foreign banks are

automated to some degree in their operations and in the ways they deliver
services. Although Internet! Online banking is still evolving and is in a
nascent stage, it seems to have taken hold of all banks. Most banks started
with just a website providing brochure information, then moved on to
transactions on the Web and are now moving forward into e-commerce.
Banks are also looking at convenience banking methods such as A
TMs, tele banking, mobile banking, and credit and debit cards.
Conservative estimates have pegged the business of IT in banking
inclusive of networking and solutions at Rs. 25,000 million (US $ 538
million 538 million).
Domestic and foreign companies providing IT and consultancy
service includes Infosys Technologies, Wipro, IBM, E-funds
Corporation, and Brokat systems. However, the areas of concern remain
security of the transaction in online banking.
India has already agreed to a greater role for foreign banks under the
WTO financial services negotiations. The major features of the offer
include the granting most favored nation (MFN) status to all foreign
banks and financial services companies. There exist restrictions on the
number of branches a foreign bank can have, although the restriction has
partly been liberalized. Foreign banks are now allowed to open twelve
new branches annually compared to a prior limit of eight branches.
Foreign banks would be treated on par with Indian banks and provided
with full market access.
MARKET ACCESS
The regulatory authority of the schedule commercial banks is the RBI.
The RBI controls the activities of the banks through the Banking
Regulation Act of 1949 and the n Act of 1934.

Entry and Licensing: A company/foreign bank intending to carry on

banking activities I India must obtain a license from the RBI. The RBI
issues a license after applying certain 'tests of entry' criteria. These tests
include minimum capital, ownership structure, bank's operating plans and
controls, ability of the bank to pay its present and future depositors in
full, quality of management and whether the licensing of the bank would
be public interest, track record of the promoters. The minimum paid-up
capital required r new private banks is Rs. 1 billion. The private sector
banks have to be publicly listed d are required to begin operations in a
fully computerized environment. The limit for n-resident ownership in a
private sector bank is 40 percent.
For foreign banks the RBI also examines the dealings of the bank
with Indian parties, international and home country ranking, international
presence, economic and relations with the home country, and supervisory
standards prevalent in the home country. The RBI also insists on prior
consent of the home country regulator and ensures that the laws of the
home country do not discriminate Indian banks.
Area of Activity: The term 'banking' in the Banking Regulation Act is

defined as 'theaccepting, for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise
and withdrawal by check, order or otherwise'. The permissible activities
of banks in India as defined in the Act include both commercial banking
and investment banking. However, banks are not allowed to undertake
mutual business departmentally. Banks are not allowed to trade in
commodities. In the monetary and credit policy for 2000-01, the RBI has
allowed banks to enter the insurance sector as agents of insurance
companies on a fee basis, without any risk participation. Banks that
satisfy eligibility criteria (insurance) are allowed to set up a joint venture

company for undertaking insurance business.
Supervision: The Banking Regulation Act (section 35) vests powers with
the RBI for inspection of books of any banking company at any time. The
supervisory system instituted by the RBI involves both on-site and off-
site surveillance. The RBI has devised supervisory rating models. For
domestic banks, rating system is based on capital adequacy, asset quality,
management, earnings, liquidity and systems and control (CAMELS), for
foreign banks system is based on capital adequacy, asset quality,
,compliance and systems (CACS). This is supplemented by off-site
surveillance in the of quarterly returns, which banks have to submit to the
RBI.
Capital Adequacy Ratio (CAR): The RBI prescribed the CAR as per the
Bassel norms gave banks time to raise the capital level in a phased
manner. With effect from April 1, 2000 all banks are required to maintain
9 percent CAR. Apart from the overall level of CAR, the RBI has also
introduced certain structural adjustments in the assignment of risk
weights on the various categories of assets. These are:
• The banks' foreign exchange open position limit as well as the open
position limit in gold has been assigned a 100 percent risk weight
with effect from March 31, 1999.
• Investment in government and other approved securities require to
be assigned a risk weight of 2.5 percent since April 1, 2000.
• Fresh investment in government guaranteed securities of Public
Sector Units that do not form part of market borrowings are subject
to an additional risk weight of 20 percent from April 1, 2001. The
investments outstanding on such securities as of March 31, 2000 will

be subjected to the risk weight in two stages of 10% each in FY2002

and FY2003.The risk weight on central and state government
securities is zero.
• Advances guaranteed state governments that have defaulted as of
March 31, 2000 are to be assigned a risk weight of 20 percent in case
the guarantee has been invoked. The risk weight will increase to 100
percent if they continue to be in default after March 31, 2001
• Liquidity - Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
(SLR). A major reform measure was the gradual reduction of the
CRR and SLR. In 1990s CRR and SLR aggregated together 53.5
percent of deposits.
The CRR refers to the minimum proportion of the net demand and
time liabilities (NDTL) that the bank must maintain in cash with the RBI.
The CRR percentage is reviewed every six months and the RBI has the
power to modify the CRR between 3 percent and 20 percent. Commercial
banks are currently required to maintain a CRR of7.5 percent of NDTL.
The existing policy is to reduce the CRR to the minimum 3 percent in line
with international norms.
The SLR expresses the quantity of certain specified assets (as
mentioned in the banking act) as a percentage of the total demand and
time liabilities. The SLR is set at 25 percent of NDTL. The RBI has the
power to modify the SLR between 25 percent and 40 percent.
Credit Controls and Delivery Systems:
Prior to the reforms initiated in 1992, there were detailed regulations

regarding the calculation of the Maximum Permissible Bank Finance
(MPBF) with norms for receivables and inventory holding for various

industries. In a phased manner from 1993 to 1997, all instructions relating

to MPBF were withdrawn with a view to providing freedom to banks.
The RBI now only provides broad guidelines (except for small-scale
industries) emphasizing the need to clearly lay down the loan policy for
each industry. Banks are free to sanction term loans for projects as long
as the exposure and concentration norms are maintained.
Interest Rates: Interest rate on deposits has been completely deregulated.

The only administered interest rate is that on savings bank deposits. On
current account balances, no interest is payable. For foreign currency
denominated deposits from non-resident Indians (NRIs), there is a ceiling
on the interest rate offered. On the lending side banks are required to
announce the Prime Lending Rate (PLR) and the maximum spread
charged over the PLR. Interest rates are currently prescribed for only
three categories of loans; loans below 200,000, lending rates for exports,
and advances in foreign currency.
Lending Limits for Single Borrower: Prudential exposure norms

have been prescribed both in respects of operations of foreign branches
and for domestic banks, lending to individual group borrowers at 25 to 50
percent of the bank's capital funds. To encourage low of funds to the
infrastructure sector, the borrower norm is fixed at higher level of 60
percent for companies engaged in infrastructure industry. A quarterly
reporting to the RBI on the exposure ceilings for off-site monitoring is in
place. The banks are required to report top 20 borrowers with balances
outstanding.
Priority Sector Lending: Norms: Domestic commercial banks (both

public and private sector)

• Total priority sector advances: 40 percent of net bank credit

• Total agricultural advances : 18 percent of net bank credit
• Advances to weaker sections : 10 percent of net bank credit
Foreign banks operating in India
• Total priority sector advances: 32 percent of net bank credit

• Advances to small-scale industries: 10 percent of net bank credit
• Export credit: 12 percent of net bank credit
The definition of the priority sector has been broadened to include:

• Loans to traditional plantation crops like tea, coffee, and rubber;
• Loans for housing up to Rs. 500,000 (US $ 10,752);
• Loans to transport operators with 10 vehicles or less;
• Advances to dealers of certain types of irrigation systems and
agricultural machinery;
• Investments made by banks in special bonds of SIDBI, NABARD,
NHB, NSIC, HUDCO, SIDCs, Rural Electrification Corporation
(REC) and contributions to Rural Infrastructure Development Fund
(RIDF) and advances up to Rs. 10 million (US $0.21 million) to
the software industry.
Investment: The market risks in the investment portfolio of banks are

controlled through quantitative restrictions on the extent of exposure that
the banks can have in capital market. Investments comprise nearly 35
percent of the total assets of the banking system. The investments can be
classified as 'approved' and 'not approved'. According to the 'edit
cy poli

for the second half of FY 2001, investments are to be classified into three
categories-held to maturity, available for sale, and held for trading. The
held to maturity category securities need not be marked to market and
cannot exceed 25 percent of the portfolio. Banks have the flexibility to
decide the extent of holdings under "available for tie" and "held for
trading”.
Transparency and Disclosure
Prior to 1992, the degree of disclosure by Indian banks in the financial
statements was minimal. The current set of rules requires the disclosure
of the following:
• All income and expenditure items with schedules.
• Accounting policies.
• Capital adequacy ratio in the balance sheet along with break-up of
capital.
• Percentage of shareholding of the government and the percentage
of net NPAs to net advances.
• Interest income as a percentage of average working funds.
• Operating profit as a percentage of average working funds.
• Return on assets.
• Business per employee.
• Profit per employee.

PROBLEM STATEMENT
• Is the Act really effective to the banks to recover the NPAs?
• Why banks are still facing the problem of swelling NPAs?
JUSTIFICATION AND SIGNIFICANCE

The banks and financial institutions have been burdened with ever
increasing non performing assets. Till 2002 neither there were any legal
provisions for facilitating securitization of financial assets of banks nor
was there any legal framework to take possession of securities and sell
them without the intervention of the court.
The securitization and reconstruction of financial assets Act 2002
was a step in this direction. The Act was bound to create ripples in the
corporate sector and at the same time provide a much needed balm to the
banks and financial institutions.
OBJECTIVE OF THE STUDY

To study the various provisions of the Act with special emphasis
on reduction of NPAs.
To study the effectiveness of the Act to the banks and financial
institutions to reduce the NPAs.
To study why banks and financial institutions are facing the
problem of swelling NPAs even after the passing of the Act.
To make a comparative study of the banks under study in respect to
recovery of NPAs after passing of the Act.

THEORETICAL FRAMEWORK
THE CONCEPT OF FINANCE

A Business enterprises success and survival depends on how
efficiently it generates funds as and when it is needed. The key to all the
business function is finance and it is rightly said “finance is the lifeblood
of business”, just as brain is essential in the human body for controlling
the activities of life, finance is the essential element for controlling the
activities of the business and its smooth functioning .
Besides being scarce in nature, it is the most indispensable
requirement. The word “finance” is the management of the monetary
affairs of the company/business firm. It is the process of organizing the
flow of funds, so that the business can carry out its objective in most
efficient manner and meets its obligation as and when they fall due. It is
the master key, which provides access to all the sources in manufacturing
and merchandising activities.
It is a fact, that money multiplies into more money when it is
properly cannelized. Hence efficient management of business is essential
and therefore financial management.
FINANCE FUNCTION:
The dominance of finance function in business activity is so much
that, one often hates its domination over other business functions.
However one cannot attempt to eliminate the status of finance from the
business activity, for businesses will have to be suspended in the absence
of finance.

Mr. Weber rightly observed that, “the commitment of funds is an

endless story, it begins but never ends”
All enterprises require a continuing commitment of funds in order
to operate.
Therefore, the management must have an idea of using the money
profitably, it may be easy to raise funds but it may be difficult to repay
them. The inflows and outflows of funds must be properly matched.
OBJECTIVES OF FINANCE FUNCTION:

The primary objective of finance is to arrange for required funds
for the business from time to time .The other objectives are:
1. Acquiring sufficient funds: The basic objective of finance is to
assess or estimate the financial requirement of an enterprise and
then finding out suitable source for raising them. The sources
selected should be commensurate with requirements of the
business.
2. Proper utilization of funds: Though selecting the source and raising
the funds is most important objective of finance function, the
proper utilization of such funds is even more critical. The funds
should be utilized in such a way that, maximum benefit is derived
from them.
3. Increasing the profitability: The planning and control of finance
function aims at increasing profitability of the concern. It is the fact
that money generates money. Sufficient funds will have to be
invested in order to increase profitability.
4. Maximizing concern values: Finance function also aims at
maximizing the value of the firm, i.e., wealth and profit
maximization.

SCOPE OF FINANCE FUNCTION:

1. Estimating financial requirements: The first and the foremost task
of the finance manager is to estimate short term financial needs of
the concern. This calls for preparation of a financial plan for
present as well as future. The amount required for purchasing fixed
assets as well as funds required for working capital will have to be
estimated. The estimation should be based on sound financial
principles so that there is neither inadequacy nor abundance of
funds in the concern.
2. Deciding capital structure: The term capital structure refers to the
kind and proportion of different securities for raising funds. After
deciding the quantum of funds required, it should be decided as to
which type of securities should be gone in for, as it affects the cost
of capital.
3. Selecting a source of finance: Once the capital structure is decided,
an appropriate source of finance is selected. The various sources of
finance include share capital, debentures, financial institutions,
commercial banks, public deposits, etc. There are various factors
that influence the selection of a particular source of finance like the
need, purpose, cost involved, attitude of the management etc.
4. Selection of pattern of investment: Once the funds have been
procured then comes the decision of investment pattern that is to be
taken. A decision has to be taken as to the type of assets that are to
be purchased. Firstly, funds may be invested in fixed assets and
then appropriate portion may be kept for the purpose of working
capital needs.
5. Proper cash management: Cash management is one of the most
important tasks of finance manager. He has to access the cash
requirements at different times and make arrangements for

acquiring cash. Management of cash much be such that neither

there is a shortage of cash nor it is idle.
6. Implementing financial controls: An efficient system of financial
management necessitates the use of various control devices.
Financial control devices generally used are ROI, Budgetary
control, Break even analysis, Cost control, Ratio analysis etc.
7. Proper uses of surplus: utilization of profits or surplus is also an
important factor in financial management, judicious use of surplus
is essential for expansion and diversification plans and also in
protecting the interest of the shareholders. Ploughing back of
profits is the best sources of financing, but clashes with
shareholders interest.
FINANCIAL MANGEMENT:
Financial management is an appendage of the finance function.
With the creation of complex industrial structure, the finance has grown
to very great heights. One cannot think of any business activity in
isolation from its financial implications.
MEANING:
Financial management refers to that part of the management
activity, which is concerned with planning, and controlling of firm’s
financial resources. It deals with various sources of raising funds for the
firm which are suitable and economical for the needs of the business,
appropriate employment of funds thereof and all business decisions has
financial implication. Financial management is applicable to every type
of organization, irrespective of size, kind of nature.

OBJECTIVES OF FINANCIAL MANAGEMENT:

Financial management evaluates how funds are procured and used.
In all cases, it involves a sound judgment combined with logical approach
of decision making. The core of financial policy is to “maximize earning
in the long run and optimize them in short run” this calls for an evaluation
of alternative uses of funds and allocation of resources for business
function.
Financial management provides a framework for selecting a course
of action and deciding an economically viable strategy.
The main objectives of a business are to maximize the owner’s
welfare. The objective can be achieved by:
1. Profit maximization.
2. Wealth maximization.
PROFIT MAXIMIZATION:
Profit earning is the primary concern of every economic activity. A

business being an economic institution is supposed to earn profits to
cover its cost and provide funds for growth. Business can survive only
when it earns profit, profit is a measure of the efficiency of a business
enterprise. It also serves as a protection against uncertain risk. It is
remuneration for innovation. The survival of the firm depends upon its
ability to earn profits. But from the experience it is learnt that concept of
maximization is a “myth”.
WEALTH MAXIMIZATION:
Wealth maximization is the appropriate objective for an enterprise.
Financial theory asserts that wealth maximization is the single substitute
for the stockholder’s utility.

The concept of wealth maximization tells the value of an asset in

terms of benefits it can produce. This concept is based on the cash flow
generated in the business. The concept of wealth maximization is
universally accepted in financial decision making. If a financial decision
results in more cash inflow then the project is considered viable.
While pursuing this objective all efforts must be put in for
maximizing the current present value of any particular course of action.
Every financial decision should be based on cost benefit analysis. There
is rational in applying wealth maximization policy as an operating
financial management policy.
KEY ACTIVITIES OF FINANCIAL MANAGEMENT

• Financial analysis, planning and control
• Management of firm’s asset structure.
• Management of firm’s financial structure.
Financial decision:
• Investment decision: The decision relates to the determination of
the total amount of assets to be held by the firm, their composition,
the business risk and the image and the firm as perceived by the
investors.
• Financing decision: A proper debt equity mix has to be fixed so as
to maximize the profitability of the concern. The cost of raising
funds for investing is very crucial in making financial decision.
• Dividend decision: This refers to disbursement of profits back to
the investors who have supplied funds.

FUNCTIONS OF FINANCIAL SYSTEM

• It provides a payment system for the exchange of goods and
services.
• It enables pooling of funds for undertakings like large scale
enterprises.
• It provides mechanism for spatial and temporal transfer of
resources.
• It provides a way of managing uncertainty and controlling risk.
• It generates information that helps in coordinating decentralized
decision making.
• It helps in dealing with the problems of informational asymmetry.
EMERGENCE OF THE WORD NON PERFORMING ASSETS
The issue relating to definition, management or mismanagement

and recommendations calling for spectacular solutions to the problem of
non performing advances of banks are being deliberated at frequent
intervals during last decade or so.
The concept of classification of bank advances in to several health

code categories began in the late 1980s though the terminology of non
performing advances was not existent at that time. This followed in early
90s with Anglo-American model of categorization of bank lending
portfolio in several blocks of nomenclature that included the non-
performing advances.
The rapid popularity of the phenomenon can be ascribed to the

opening up of the Indian economy and consequent pressure from western
powers to influence our banking system in the name of international

standards of accounting, congruence of banking supervision by Basle

committee, and so on.
The sudden shock of guidelines relating to non performing

advances and simultaneous standard of income-recognition made the
Indian banking system totter and a number of public sector banks started
incurring losses from the mid nineties. Then came the recommendations
of the Narsimhan committee with the proposition of creating asset-
reconstruction fund for cleaning the balance sheets of the banks of non-
performing advances as a one-time measure. Though it was a rather
difficult, it is not impractical debate.
The other major creation of 90s namely, the debt recovery

tribunals, which were, establish to recover the mounting overdues of
financial institution did not provide the necessary impetus to solve the
problem of non-performing assets of banks under DRT, since banks were
prevented from initiating court-proceedings
The latest two developments in this regard are more perplexing:
The reported recommendations by the sub-committee if CII for

closure of weak banks plagued by the serious problem of non-performing
advances(later withdrawn by them) and now the apparent move to form
corporate debt recast body modeled on the corporate debt-recast advisory
committee (CDRAC) of The Bank of Thailand.
Concept and Evolutionary process in India:
The banks being financial intermediaries are in the business of

accepting deposits for the purpose of lending and to augment their
resources, they borrow money from other sources, at times and meet the

ever-increasing borrowing requirements of their customer. However,

most of the business, which banks do, is done with the funds collected
form the public by way of deposits. They are therefore, accountable for
the general public, who are keeping their funds with banks by reposing
trust in the ability of banks that they will not put the depositors’ interest
to jeopardy by creating assets, which do not generate income or are not
worth realization in cash. In view of this, the subject of management of
assets, with the objective of improving the yields has been an important
issue for bankers and regulatory authorities in India and in the interest
deregulation regime, the management of assets and liabilities gains more
importance because of volatile situation.
Till early 1990s, there are used to be no well established data

available indicating the correct health of banking assets, as section 34-A
of Banking Regulation Act 1949 provided shelter to the banks and it was
not obligatory for them to disclose the size of their bad and doubtful
debts. However there were certain indicators, which spelt out the fact that
the health of banking assets deteriorated over a time period. Among
various indicators were a large number of suit-filed accounts, substantial
increase in the number of sick units, mounting overdue, increase in legal
expenses and decline in spreads i.e., interest earned and paid. However,
now the banks have been made to disclose the classification of their
assets in standard, sub-standard, and doubtful and loss assets categories,
which provide some insight into the qualitative aspect of affairs.

Various Kinds of Banking Assets:
1. Cash in hand
Balance with RBI
- In current account
- In other accounts
2. Balances with banks and money at call and short notice.

Balance with banks
- In current accounts
- In other deposit accounts
- Money at calls and short notice with banks
3. Investment
-Govt. securities.
-Other approved securities -Shares
-Debentures and bonds
-Subsidiaries and Or joint ventures.
-Others
4. Advances
-Bills purchased
-Cash credit and overdrafts and loans payable on demand.
-Term loans.
(Advances can be classified in a no of ways, as prescribed by RBI
In the revised balance sheet format schedules)

5. Fixed assets
-Premises
-Other fixed assets (including furniture and fixture)
6. Other assets
-Inter-office adjustments
-Inter on investments not collected
- Tax paid in advance
-Stationery and stamps
-Non-banking assets acquired
-Others
The banking assets, as such, may form a category yielding returns
or these may relate to a segment not generating and revenue. In later case,
a section of such assets may fall into sub-category known as non-
performing assets.
Kinds of non-performing assets:

Banks assets can be classified into three categories, namely
financial, Infrastructural and manpower, is conspicuously invisible in the
balance sheet of the banks, the third one i.e., manpower conspicuously
invisible in the balance sheet and is represented by staff costs in
accounting terms, although otherwise, the most significant in real terms,
particularly for a service industry like banking.
A non-performing financial asset such as advance or loan is one,
where interest lion has been stopped due to its identification consideration
as a sub-standard t on account of various reasons, under guidelines of
Government /RBI or internal of the banks/financial institutions based on
their system prescribed for this purpose. Technically, such financial
assets may also include impersonal accounts like suspense, drafts paid,

clearing adjustment items and investments, which are not yielding

income, but in real terms their recoverability not being in doubt, they are
not categorized as non-performing assets.
An infrastructural asset: The premises, equipment, furniture,
vehicles and the like, constitute the infrastructural assets or physical
assets. The balance sheets provide the details of their quantum, annual
additions/deletions and depreciation deducted there from.
The information on obsolescence or performance of these assets is,
unfortunately, not available either through financial statements or any
other management information systems. The indicators for judging the
performance of these assets will thus not be available. Instance of
obsolete machinery, out of order vehicles, wastage or underutilization of
premises and the like, are not infrequent. However, it seldom receives
attention of managements in banks and no relevant data are available
about these aspects.
The manpower asset i.e. staff, which are not utilized wholly or
partly, in lance with the expectations/requirements (quantitative or
qualitative) laid down by the bank for performance and productivity, can
also be considered as non-performing from various angels. These may
include the staff having low morale, no motivation and carrying
frustration for a number of reasons.
The subject matter of this book, however, is the non-performance of
that segment of the financial assets which are called non-performing
loans. Data on non-performing advances for individual banks and is given
at the end of this chapter.
Non -performing assets: Traditional view

The non-performing advances, as they are known in the banks today,
are not a new development or something new. From times immemorial,

the banks and financial institutions have been facing problem of their
loans and investments proving difficult of recovery and turning out to be
bad assets, here not only interest could not be recovered from the
borrows, but on a no of occasion even the principal had to be
compromised/ written off. It has to be accepted that the banking business,
by its nature, is fraught with risk of non-repayment. The concept has
covered a long journey to reach the present stage.
A non-performing asset in banking parlance was termed for an asset
not contributing to the income of the bank. In the other words, it was a
zero-yield asset, where the recovery of principal was not to take effect in
normal course without extra effort and/or drastic actions. The bankers use
to categorize such assets as sticky, recalled, protested, and difficult of
recovery or suit-file advances, to which the interest was not debited and
taken to revenue of the bank. Though the banks use to bear the cost of
funds along with other costs and charges for this asset, there was no
income from such advances. However since the approach of the banks
then was to grant advances against good securities and provisioning
norms were based on security consideration, they were saved of making
provisions in majority of the cases and in the process, the profit provision
was not adversely affected on account of provisions to the extent, it gets
affected now.
Non -performing assets- Uniform approach based on health code

system:
Before RBI prescription on recognition of income from advance,
different banks used to follow their own prudence in recognizing income
on accrual basis rather than the realization and considered such assets as
non-performing based on income yield. Some of the banks had long
stopped the practice of debiting the loan accounts with interest falling in

the category of recalled, protested, suit-filed, decreed and bad and

doubtful advances while others continued debiting the interest in the case
of advances coming under some of the above categories. Hence, banks till
1985 followed no uniform practice.
As a first step towards bringing in uniformity in practice relating to
recognition of the non-performing status of problems of loans and
advances, Reserve Bank had advised the commercial banks in the year
1986 that in respect of loans which are categorized under health codes 5
to 8(recalled, suit-filed, decreed, bad and doubtful debts) interest should
not be booked and taken to profit and loss account, irrespective of the
security positions or the realisability assessment of the banks, unless
interest is already realized. However, category 4 (sick non-viable)
accounts were left to the banks for deciding accrual status.
Non -performing assets- new approach based on record of recovery:

Reserve Bank W.e.f, April 1992 decided that if the balance sheet
is to reflect a banks actual financial health, a proper system for
recognition of income, classification of assets and provisioning for bad
debts on a prudential basis is necessary. The committee on financial
system under the chairmanship of shri.M.Narasimhan examined these
issues and recommended that the policy income recognition should be
objective and based on record of recovery rather than on any subjective
considerations. Likewise, the classification of assets has to be done on the
basis of objective criteria, which would ensure a uniform and consistent
application of norms. As regards provisioning requirements, the
committee recommended that the basis of classifications of assets into
different categories. (Standard, sub-standard, doubtful and loss assets)
Reserve Bank implemented the new system in a phased manner over

a three years period commencing with the accounting year beginning

1.4.1992 according to which the basis for treating a credit facility as Non-
performing assets are given below:
CONCEPT OF PAST DUE:

The loans and repayment there of are inter-related and all loans
have to be paid back by the borrower as per terms on which they are
sanctioned. These become due for payment in installments or on the
happening of some other event. The question of a loan asset becoming
Non-performing will normally not arise where it is not made to be repaid.
When the repayment is not made in time, an amount is considered
as past due if it remains unpaid for 30 days beyond due date. E.g., if in an
SSI loan account, the repayment of term loan falls due for payment on
Dec 31 and is not paid by that date, the amount would become past due if
it remains unpaid for 30 days beyond that date. Before RBI adopted the
concept of past due, the banks at their level used to term such delays as
overdues.
TRANSFORMATION OF ASSETS INTO NON-PERFORMING:

CAUSES
There are various external and internal factors behind the
transformation of assets from performing to Non-performing, some of
which are:
¾
Internal factors may include improper assessment of returns from
the activities being financed, repaying capacity and risk bearing
ability of the borrowers, improper evaluation of the credit
requirements of the borrowers, which may affect the cost and
revenue structure of the activity and may render the activity

unviable, improper assessment of the experience of the borrower or

his capacity to pursue the activity, improper assessment of the
indebt ness of the borrower to other institutions and individuals,
improper assessment about the project location and locational
advantages, improper assessment of the forward and backward
linkages upon which the viability of the activity to be pursued
depends to a larger extent, improper assessment of the prices of
equipments, machinery etc., of the project, the borrower proposing
to take up with the bank assistance, thereby creating financial
problems at the outset, fixing up the repayment schedule and
gestation period unrealistically, lack of supervision and follow-up
on the part of the bank branches for various reasons.
¾
External factors may include unwillingness of the borrowers to
repay to loss, natural calamities/risks such as draught, floods,
occurrence of epidemics, unexpected changes in whether etc.,
which are beyond the control of individual borrowers, lack of
linkage of credit with marketing, dispute between the co--
borrowers, or death of anyone of them after availing the advance
from the bank, breach of trust by the borrowers and /or he
purchasing agency under tripartite arrangement, involvement,
changing social, moral and political values over a period time.
In case of most of the large and medium scale industries, the main
reasons for Nonperformance have been found to be mismanagement,
power shortage, outmoded machinery/ technology, fluctuations in supply
of raw materials, non-release of subsidy/concessions in time which might
have been committed at the initial stage by the Government and
deficiency in demand and uncertain market condition. The SSIs are prone

to sickness mainly due to lack of managerial experience, technical

incompetence and decline in demand for their products an overall demand
recession. Further the delay in payment of supply bills by Government
organisations and large units, lack of quality consciousness and poor
marketing methods are also contributory factors which transformed bank
assets into Non-performing ones.
Further, cases are not unknown where deliberate efforts are made by
a certain category of borrowers to declare their units sick and weak to
avail of pecuniary benefits from different source. Even a certain category
of prudent borrowers do not hesitate to reap undue advantages of certain
lapses on the part of the bankers as they come to know during their
experience, that documentation may not be in order, securities made
available for the loan may not be intact, bankers may not be in order,
securities made available for the loan may not be intact, bankers may not
be in a position to proceed legally due to various reasons and they
ultimately, these loans turn into Non-performing assets. Government
policies are also responsible to some extent for adding to the volume of
Nonperforming assets of banks. Various incentives, concessions, waiver
of the loan repayment, extension and postponement of recovery are some
of the factors, which influence the borrower to take shelter. In course of
time majority of loans become to take shelter. In course of time majority
of the loans became irrecoverable. This can be substantiated by the fact
that the majority of the loans in the small loans category are reported to
fall under the category of Non-performing category.
One of RBI studies on sickness in the industries sector revealed that

in case of about 52% units, mismanagement, diversion of funds and
infighting amongst owners is the reason for sickness, 23% units became

sick because of inadequate marketing and faulty initial planning and

technical drawbacks caused sickness in case of 14% units. Failure on the
power front or paucity of raw material resulted in sickness of about 9%
and only 2% became sick because of labour problems.
OTHER CAUSES:
• Intentional defaulters and faulty project
• Natural calamities, recession, vagaries in Government, policies,
changes in economic & climatic conditions
• Most project reports are bereft of ground realities, proper linkages,
product, pricing etc.
• Some approach, for the "heck" of starting a Venture, with poor
knowledge of product risks, over dependent on poorly paid skilled
workers and technicians.
• Building up pressure for sanctions
• Inept handling by bankers, lack of professionalism, and appraisal
standard
• Non observances of system, procedures, and non insistence of
collaterals etc. wherever eligible/available
• Prolonged evaluation seeking frustrating borrowers by unwanted
clarifications
• Lack of post sanction monitoring, unchecked diversions
• Directed lending under subsidy schemes without proper delivery
system, infrastructure etc.
• "Stick in time saves nine" timely support/help may save a genuine
unit. Have HEAD & HEART together, for a HUMANE approach.

NON-PERFORMING ASSETS
It's a known fact that the banks and financial institutions in India face
the problem of swelling non-performing assets (NP As) and the issue is
becoming more and more unmanageable. In order to bring the situation
under control, some steps have been taken recently. The Securitization
and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 was passed by Parliament, which is an important step
towards elimination or reduction of NPAs.
Indian economy and NP As:

Undoubtedly the world economy has slowed down, recession is at its
peak, globally stock markets have tumbled and business itself is getting
hard to do. The Indian economy has been much affected due to high fiscal
deficit, poor infrastructure facilities, sticky legal system, cutting of
exposures to emerging markets by FIls, etc.
Further, international rating agencies like, Standard & Poor have
lowered India's credit rating to sub
-investment grade. Such negative
aspects have often outweighed positives such as increasing forex reserves
and a manageable inflation rate.
Under such a situation, it goes without saying that banks are no
exception and are bound to face the heat of a global downturn. One would
be surprised to know that the banks and financial institutions in India hold
non-performing assets worth Rs l, 10,000 crores. Bankers have realized
that unless the level of NP As is reduced drastically, they will fin it
difficult to survive.
Global Developments and NPAs

The core banking business is of mobilizing the deposits and
utilizing it for lending to industry. Lending business is generally

encouraged because it has the effect of funds being transferred from the
system to productive purposes, which results into economic growth.
However lending also carries credit risk, which arises from the
failure of borrower to fulfill its contractual obligations either during the
course of a transaction or on a future obligation.
A question that arises is how much risk can a bank afford to take?
Recent happenings in the business world - Enron, WorldCom, Xerox,
Global Crossing do not give much confidence to banks. In case after case,
these giant corporate became bankrupt and failed to provide investors
with clearer and more complete information thereby introducing a degree
of risk that many investors could neither anticipate nor welcome. The
history of financial institutions also reveals the fact that the biggest
banking failures were due to credit risk.
Due to this, banks are restricting their lending operations to secured
avenues only with adequate collateral on which to fall back upon in a
situation of default
Why such huge levels of NP As exist in the Indian banking system

(IBS)?
The origin of the problem of burgeoning NP As lies in the quality of
managing credit risk by the banks concerned. What is needed is having
adequate preventive measures in place namely, fixing pre-sanctioning
appraisal responsibility and having an effective post-disbursement
supervision. Banks concerned should continuously monitor loans to
identify accounts that have potential to become non-performing.

Why NPAs have become an issue for banks and financial institutions
in India?
To start with, performance in terms of profitability is a benchmark
for any business enterprise including the banking industry. However,
increasing NP As have a direct impact on banks profitability as legally
banks are not allowed to book income on such accounts and at the same
time banks are forced to make provision on such assets as per the Reserve
Bank of India (RBI) guidelines. Also, with increasing deposits made by
the public in the banking system, the banking industry cannot afford
defaults by borrower s since NP As affects the repayment capacity of
banks.
Further, Reserve Bank of India (RBI) successfully creates excess
liquidity in the system through various rate cuts and banks fail to utilize
this benefit to its advantage due to the fear of burgeoning non-performing
assets.
What does Accounting Standard 9 (AS 9) on revenue recognition

issued by ICAI say?
The Accounting Standard 9 (AS 9) on 'Revenue Recognition' issued
by the Institute Of Chartered Accountants of India (ICAI) requires that
the revenue that arises from the use by others of enterprise resources
yielding interest should be recognized only when there is no significant
uncertainty as to its measurability or collectability.
Also, interest income should be recognized on a time proportion
basis after taking into consideration rate applicable and the total amount
outstanding.

Are RBI guidelines on NP As and ICAI Accounting Standard 9 on

revenue recognition consistent with each other?
In view of the guidelines issued by the Reserve Bank of India (RBI),
interest income on NP As should be recognized only when it is actually
realized.
As such, a doubt may arise as to whether the aforesaid guidelines
with respect to recognition of interest income on NP As on realization
basis are consistent with Accounting Standard 9, 'Revenue Recognition'.
For this purpose, the guidelines issued by the RBI for treating certain
assets as NP As seem to be based on an assumption that the collection of
interest on such assets is uncertain.
Therefore complying with AS 9, interest income is not recognized
based on uncertainty involved but is recognized at a subsequent stage
when actually realized thereby complying with RBI guidelines as well.
Credit Risk and NPAs

Quite often credit risk management (CRM) is confused with
managing non-performing assets (NPAs). However there is an
appreciable difference between the two. NPAs are a result of past action
whose effects are realized in the present i.e. they represent credit risk that
has already materialized and default has already taken place.
On the other hand managing credit risk is a much more forward-
looking approach and is mainly concerned with managing the quality of
credit portfolio before default takes place. In other words, an attempt is
made to avoid possible default by properly managing credit risk.
Considering the current global recession and unreliable information
in financial statements, there is high credit risk in the banking and lending
business.

To create a defense against such uncertainty, bankers are expected to

develop an effective internal credit risk models for the purpose of credit
risk management.
How important is credit rating in assessing the risk of default for

lenders?
Fundamentally Credit Rating implies evaluating the
creditworthiness of a borrower by an independent rating agency. Here
objective is to evaluate the probability of default. As such, credit rating
does not predict loss but it predicts the likelihood of payment problems.
Credit rating has been explained by Moody's a credit rating agency
as forming an opinion of the future ability, legal obligation and
willingness of a bond issuer or obligor to make full and timely payments
on principal and interest due to the investors.
Banks do rely on credit rating agencies to measure credit risk and
assign a probability of default.
Credit rating agencies generally slot companies into risk buckets
that indicate company's credit risk and are also reviewed periodically.
Associated with each risk bucket is the probability of default that is
derived from historical observations of default behavior in each risk
bucket.
However, credit rating is not foolproof. In fact, Enron was rated
investment grade till as late as a month prior to it's filing for Chapter 11
bankruptcy when it was assigned an in-default status by the rating
agencies. It depends on the information available to the credit rating
agency. Besides, there may be conflict of interest, which a credit rating
agency may not be able to resolve in the interest of investors and lenders.
Stock prices are an important (but not the sole) indicator of the
credit risk involved. Stock prices are much more forward looking in

assessing the creditworthiness of a business enterprise. Historical data

proves that stock prices of companies such as Enron and WorldCom had
started showing a falling trend many months prior to it being downgraded
by credit rating agencies.
Usage of financial statements in assessing the risk of default for

lenders
For banks and financial institutions, both the balance sheet and
income statement have a key role to play by providing valuable
information on a borrower's viability. However, the approa
ch of
scrutinizing financial statements is a backward looking approach. This is
because; the focus of accounting is on past performance and current
positions.
The key accounting ratios generally used for the purpose of
ascertaining the creditworthiness of a business entity are that of debt-
equity ratio and interest coverage ratio. Highly rated companies generally
have low leverage. This is because; high leverage is followed by high
fixed interest charges, non-payment of which results into a default.
Capital Adequacy Ratio (CAR) of RBI and Baste committee on

banking supervision
Reserve Bank of India (RBI) has issued capital adequacy norms for
the Indian banks. The minimum CAR, which the Indian Banks are
required to meet at all, times is set at 9%. It should be taken into
consideration that the bank's capital refers to the ability of bank to
withstand losses due to risk exposures.
To be more precise, capital charge is a sort of regulatory cost of
keeping loans (perceived as risky) on the balance sheet of banks. The
quality of assets of the bank and its capital are often closely related.

Quality of assets is reflected in the quantum of NPAs. By this, it implies

that if the asset quality were poor, then higher would be the quantum of
non performing assets and vice-versa.
Market risk is the risk arising due to the fluctuations in value of a
portfolio due to the volatility of market prices.
Operational risk refers to losses arising due to complex system and
processes.
It is important for a bank to have a good capital base to withstand
unforeseen losses. It indicates the capability of a bank to sustain losses
arising out of risky assets.
The Basel Committee on Banking Supervision (BCBS) has also
laid down certain minimum risk based capital standards that apply to all
internationally active commercial banks. That is, bank's capital should at
least be 8% of their risk-weighted assets. This infect helps bank to
provide protection to the depositors and the creditors.
The main objective here is to build a sort of support system to take
care of unexpected financial losses thereby ensuring healthy financial
markets and protecting depositors.
Excess liquidity? No problem, but no lending please!!!

One should also not forget that the banks are faced with the problem
of increasing liquidity in the system. Further, Reserve Bank of India
(RBI) is increasing the liquidity in the system through various rate cuts.
Banks can get rid of its excess liquidity by increasing its lending but,
often shy away from such an option due to the high risk of default.
In order to promote certain prudential norms for healthy banking

practices, most of the developed economies require all banks to maintain
minimum liquid and cash reserves broadly classified into Cash Reserve

Ratio (CRR) and the Statutory Liquidity Ratio (SLR).

Cash Reserve Ratio (CRR) is the reserve which the banks have to
maintain with itself in the form of cash reserves or by way of current
account with the Reserve Bank of India (RBI), computed as a certain
percentage of its demand and time liabilities. The objective is to ensure
the safety and liquidity of the deposits with the banks.
On the other hand, Statutory Liquidity Ratio (SLR) is the one which
every banking company shall maintain in India in the form of cash, gold
or unencumbered approved securities, an amount which shall not, at the
close of business on any day be less than such percentage of the total of
its demand and time liabilities in India as on the last Friday of the second
preceding fortnight, as the Reserve Bank of India (RBI) may specify from
time to time.
A rate cut (for instance, decrease in CRR) results into lesser funds to
be locked up in RBI's vaults and further infuses greater funds into a
system. However, almost all the banks are facing the problem of bad
loans, burgeoning non-performing assets, thinning margins, etc. as a
result of which, banks are little reluctant in granting loans to corporate.
As such, though in its monetary policy RBI announces the bankers
no longer warmly greet rate cut but such news.
High cost of funds due to NP As

Quite often genuine borrowers face the difficulties in raising funds
from banks due to mounting NP As. Either the bank is reluctant in
providing the requisite funds to the genuine borrowers or if the funds are
provided, they come at a very high cost to compensate the lender's losses
caused due to high level of NPAs.
Therefore, quite often corporate prefer to raise funds through
commercial papers (CPs) where the interest rate on working capital

charged by banks is higher.

With the enactment of the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002, banks
can issue notices to the defaulters to pay up the dues and the borrowers
will have to clear their dues within 60 days. Once the borrower receives a
notice from the concerned bank arid the financial institution, the secured
assets mentioned in the notice cannot be sold or transferred without the
consent of the lenders.
The main purpose of this notice is to inform the borrower that either
the sum due to the bank or financial institution is paid by the borrower or
else the former will take action by way of taking over the possession of
assets. Besides assets,' banks can also takeover the management of the
company. Thus the bankers under the aforementioned Act will have the
much-needed authority to either sell the assets of the defaulting
companies or change their management.
But the protection under the said Act only provides a partial solution.
What banks should ensure is that they should move with speed and
charged with momentum in disposing off the assets. This is because as
uncertainty increases with the passage of time, there is all possibility that
the recoverable value of asset also reduces and it cannot fetch good price.
If faced with such a situation than the very purpose of getting protection
under the Securitization Act, 2002 would be defeated and the hope of
seeing a must have growing banking sector can easily vanish.
INCOME RECOGNITION, ASSETS CLASSIFICATION AND

PROVISIONING (NON-PERFORMING ADVANCES)
Reserve Bank started implementing the prudential guidelines on
asset classification, income recognition and provisioning on the
recommendations of Narasimhan committee, in a phased manner

commencing with the accounting year beginning from 1.4.1992 and

modified the original guidelines on a number of occasions.
Past due-The basis for treating a credit facility as non-performing
was 'past due' (the due amount remaining unpaid for a period of 30 days
from due date). The concept of past due has now been dispensed W.e.f
the year ending March 2001
What is a non-performing asset?

A. Non-performing asset (NP A) is an advance where:
a) Interest and or installment of principal remain overdue for a period of
more than 180days* in respect of Term Loan,
b) The account remains out of order for a period of more than 180days*
in respect of an Overdraft/Cash credit (OD/CC),
c) The bill remains overdue for a period of more than 180days*, in the
case of Bills purchased and discounted,
d) 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 purposes,
e) And any amount to be received remains overdue for a period of more
than 180 days* in respect of other accounts.
*NOTE: the period of 180days is been reduced to 90 days W.e.f the year
ending 31.03.04.
Out of Order for Cash Credit / Overdraft Accounts:

a) When outstanding balance is more than drawing power is sanctioned
limit.
b) When credit in the account are not at all or less than the interest
debited, even though o/s balance is within the sanctioned
limit/drawing power.

c) When the stock statement is delayed for 3months or renewal of limits

does not take place is delayed for 3 months (6 months in exceptional
cases), even though the sanctioned limit/drawing power.
Implications of accounts becoming non-performing assets:
A. Banks cannot credit income to their profit and loss account to the
debit of loan account unless recovery thereof takes place.
B. Interest or other charges already debited but not recovered have to
be provided for.
C. All loan accounts of the borrower would treats as non-performing
assets.
EXISTING REVISED GUIDELINES
(w.e.f.31-03-04)
1. Interest and/or installments of 1. Interest and/ or installment of

principal remain overdue for a principal remain Overdue for a period
period of more than 180 days in of more than 90 days in respect of a
respect of a term loan. term loan.
2. The account remains “out of 2. The account remains “out of order”
order” in respect of an overdraft/ in respect of an overdraft/ cash credit
cash credit (OD/OC) for 180 (OD/OC) for 90 days.
days.
3. The bills remain overdue for a 3. The bills remain overdue for a
period of more than 180 days in period of more than 90 days in the case
the case of bills purchased and of bills purchased and discounted.
discounted.
4. Interest and/or installment of 4. Interest and/or installment of
principal remains overdue for a principal remains overdue for two
period not exceeding two and harvest seasons but for a period not
half years in the case of advance exceeding two and half years in the
M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN76
granted for agriculture purpose , case of advance granted for agriculture
and purpose , and
period not exceeding two and harvest seasons but for a period not
half years in the case of advance exceeding two and half years in the
granted for agriculture purpose , case of advance granted for agriculture
and purpose , and
5. Any amount to be received 5. Any amount to be received remains
remains overdue for a period of overdue for a period of more than 90
more than 180 days in respect of days in respect of other accounts.
other accounts.
Advances: I.R.A.C: Asset Classification/provisioning (Narasimhan

Committee Recommendations)
Income Recognition: Consequent upon the fresh guidelines issued by the
RBI relating to the concept of income Recognition, it has been decided
that income in respect of advances should not be recognized unless it is
realized.
Asset classification: All advances of the banks are now required to be
classified into 4 broad groups.
Security/worth: The availability of security or the net worth of the
borrower /guarantor is
not taken into account for the purpose of treating an advance as NP A or
otherwise.
Purpose: the guidelines issued by the RBI in respect of income
recognition, asset classification, provisioning, investments, are going a
long way in refining the accounting procedures for Indian Banks, vital for
them to assume an increasingly larger role in the international
perspective. The World Bank has suggested further tightening of these
norms.
Health code system: the asset classification of advances was not
introduced to replace the earlier system of health code-wise classification

of borrowers’ accounts (W.e.f 1.04.1994) The new asset classification is

used for determining the provisions for loan accounts. The health code
classification of borrowers’ accounts continued till 31.03.1994 as a
management information tool.
New committee: The RBI committee under Dr. Tarapore, Dy. Governor,
to examine the ways of softening the norms.
Classification of Assets/ Provisioning * Requirements

IRAC NORMS: The bank has adopted the IRAC norms prescribed by the
RBI with some modifications:
a. The bank has adapted a more prudent approach by classifying all
accounts into any of the four asset categories respective of their
outstanding and identifying provision account-wise.
b. In banks, any commitment (either installment or principal or interest)
that has fallen due for payment is also taken to be past due immediately.
The grace period of 30 days is not reckoned for deciding past-due status.
Standard Assets: It is not a NPA (non-performing assets). It does not
disclose any problem and does not carry more than normal risk.
Provisioning:
@2.5% for standard assets with out standings upto Rs. 25000/-
provisioning
@ 5% from 1993-94 onwards. Presently, no provisions are required to be
made by SBI for this category of advances. Such advances are also now
classified as per IRAC norms.
Sub-Standard Assets: It is an NP A for a period not exceeding 2 years.

In such case, there is a distinct possibility that bank will sustain
some loss if deficiencies are not corrected.

In case of term loans were installments of principals are due for

period exceeding 1 year but not exceeding 2 years, should be treated as
sub-standard.
An asset where there has been rephasement/rescheduling of
principal/interest amount should be classified as sub-standard and should
remain in that a category for at least 2 years of satisfactory performance
under the pre-scheduled terms.
The period of 2 years is prescribed for upgrading an asset only where,
the terms of loan agreement regarding interest and principal has been
renegotiated/rescheduled after the commencement of commercial
production.
Example: A loan account is classifies as substandard as on 31-3 -1997.
The loan account is not rescheduled/rephrased. During 97-98, recovery of
all over-due installments and interest (upto-date) takes place. This asset
can be upgraded to standard asset (without waiting for 2 years).
Provisioning:
A general provision of 10% of total outstanding excluding I.N.C.
unrealized interest of "previous" year and DICGC/ECGC guarantee
(retainable portion) was required to be made for this category till the year
94-95. W.e.f the year 1995-96 general provision of 10% substandard
assets without making any allowance for DICGC/ECGC cover and
securities available.(i.e. provision on 10% of outstanding reduced by an
amount held in I.N.C. account, unrealized interest of previous year (if
any) ).
Note: realizable value of tangible security is not deducted for this

purpose.

Doubtful assets: A doubtful asset is the one, which has remained NP A

for a period exceeding 2 years. In case of term loan where the
installments of principal have remained over-due for a period exceeding 2
years, it should be treated as doubtful.
An asset should be treated as "doubtful asset" if the following
criteria are satisfied:
The realizable value (salvage value of tangible security + the retainable
portion of DICGC/ECGC guarantee cover, if available) is 20% or more of
the outstanding, (or Rs 100000/- and over whichever is lower).
As in the case of substandard assets here also, assets
rephasement/rescheduling does not entitle the bank to upgrade quality of
the advance automatically.
Provisioning:

100% to the extent the advance is not covered by realizable value
of tangible security estimated on realistic basis, calculated as under
(borrowers/guarantees or network should be treated as unsecured).
100% of "adjusted" value of unsecured portion, that is @ 100% of
outstanding reduced by amount held in I.N.C. account, unrealized
interest of previous year (if any), realizable value of tangible
security and retainable amount guarantee of
government/DICGC/ECGC- this is a specific portion.

Over and above item
¾
An adhoc provision is required to be made from 20% to 50%
of the unsecured portion (i.e. realizable value of tangible
security) for which the advance has been considered as
doubtful depending upon the period given below.

Upto 1 year: Classified as doubtful, or remain as

NP A for upto and including 3 years: 20%
1 - 3 years: Classified as doubtful, are remained

as NP A for 3-5 years:30%
over 3 years: Classified as doubtful, or remained as

NP A for more than 5 years:50%
Loss Asset: A loss asset is one where loss has been identified by the bank
or internal /external RPA but amount has not been written-off partly or
wholly.
Such an asset is considered un-collectable and of such little value
that it's continuous as a
bankable asset is not warranted, although there may be salvage or
recovery value.
Provisioning:
Specific provisioning: the entire asset should be written-off, or
alternatively, if it is permitted to remain in the banks books for some
reason than 100% of the outstanding of the less amount of I.N.C. (if any)
should be provided for.
The branches are required, however, to write-off, make of
provisions through IHO after obtaining the approvable of the appropriate
authority in the bank.

Regulatory Framework
Variable 1992- 2000- 2001- 2002-
93 01 02 03
1 2 3 4 5
Capital to Risk-weighted Assets Ratio

(per cent)
Domestic banks with 4 9 9 9
International business
Foreign banks 8 9 9 9
Non-performing assets
(period overdue)
Sub-standard assets 4Q 2Q 180 180
Days Days #
Doubtful assets (period 24M 18M 18M 18M @
for which remained
sub-standard)
Provisioning Requirements (per cent)
Standard assets - 0.25 0.25 0.25
Sub-standard assets 10 10 10 10
Doubtful assets 100 100 100 100
(unsecured portion)
LOSS assets 100 100 100 100
# 90 days from March 31, 2004.

@ 12 months from March 31, 2005
Q Quarters; M Months.

NORMS FOR INCOME RECOGNITION:

Non-Performing Assets (NP A):
Definition: An asset, which seizes to yield income is NP A. Income from
NP A is not recognized on accrual basis but it is booked as income only
when income actually recovered.
TERM LOAN: where interest and installments remain PAST-DUE for:

4 quarters for: year ending 31-3-1993
2 quarters for year ending 31-3-1995 onwards
PAST-DUE is an amount due under any credit facilities not paid

under due date. In banks, PAST-DUE is taken to mean that the amount in
question as for due for payment. No further period of 30 days after the
payment falls due 9a suggested in RBI circular) for operational reasons.
Higher amounts of interests or installment for different quarters
should be realized.
Term loans include any facility in the nature of a loan repayable in
installments or on specified date. It also includes TL, WCTL, Bridge
loans, etc..
Identifying NPA- 2 Quarter loans: in a term loan account
installment or interest due upto 30th September 1997 has been paid. It is
not an NPA as on 31-3-1998. Such an account is classified as a standard
asset. (For the year ended 31st march 1995 and onwards) A term loan
account is not treated as NP A, if installments and interest have been
recovered upto an inclusive of the quarter under 30th September.

CASH CREDIT AND OVER DRAFT:
Where account remains out of order:
4 quarters for : year ending 31-3-1993

2 quarters for: year ending 31-3-1995 onwards
Out Of Order Means:
a) Where OIS balance remains continuously in excess of the sanctioned

limit/DP.
b) Where OIS balance in an account is less than sanctioned limit/DP but:
1) There are no credits in the account continuously for six months
as on
Balance sheet date of the bank, i.e.: 31st March of each year
Or
2) Credits are not enough to cover interest debited during 6 months
as on balance sheet date of the bank i.e.: 31st March of each year.
Cash credit and overdraft:

Include cash credit hypothecation (stocks/book debts) cash credit pledge,
packing credit advance against trust receipt, clean bar, secure over draft
for collection/book debts/ term deposits, fixed assets etc,

BILLS PURCHASED & DISCOUNTED:
Where bills remains overdue and unpaid for

2 quarters from: year ending 31-3-1995 onwards
Overdue interest should not be charged and taken to income account in

respect of overdue bills unless it is realized.
Bills Purchased & discounted: include demand/usance bills.
O.D.P. cheques a/c: The asset classification of the accounts is borrower-
wise. If one of the borrower accounts (including DDP a/c) becomes NPA,
all his accounts are required to be classified as NP A the (DDP-cheques
a/s of various borrowers may remain continuously irregular (2 quarters or
more) due to exceeding the sanctioned limits or non-receipt of payment
advices from the drawee branches.
OTHER ACCOUNTS:
Same yardstick applies:

2 quarters from: year ending 31-3-1995 onwards
Other Accounts: Include those accounts which cannot fit into any of the
above three categories.
INCOME RECOGNNITION & ASSET CLASSIFICATION (LR.A.C.)

Asset classification:
Applicability: In SBI, all advances, irrespective of the size/outstanding
have to be classified into different categories as per their status as
performing on non – performing assets (i.e., as per I.R.A.C. norms)
Appropriate provisions should be made there on as applicable to sub-
standard, doubtful and loss assets.
Facility-wise: Classification of assets should be done borrower-wise.
But the interest booking should be done borrower-wise (i.e., account-wise
e.g., C.C., T.L., D.L, etc.); earlier, interest booking was being done
borrower wise.
Authority structure: The prescribed authority structure is applicable it is
of permanent in nature
The conformation of asset classification must be obtained for all accounts
every year. Age of NP A: It is proper to treat 31ST march, i.e., the referral
date on which the assets are required to be classified, as the date of NPA
Term loan: As account is treated as NP A if installment/interest remains

'past due' for 2 quarters for the year ending 1994
-95 onwards.
If interest or installment of principal is in arrears for any 2 quarters out of
the 4 quarters,
the credit facility should be treated as NPA
Advanced secured against TDRs /NSCs /LIC policies, etc
RBI has advised that advances against term deposits/NSCs/surrender
value of life insurance policies, indira/ kisan vikas Patras are excluded
from provisioning requirements.
Banks need not treat such accounts as NP As and make provisions

in expect of such advances although interest has been debited for 2
quarters and not paid by the borrowers. income on such advances may

also be taken to income accounts ON THE DUE DATES, provided

adequate margin is available in the account.(the outstanding in the
accounts must be less than the advance value of relative security).
RBI have recently clarified that in case of advances against the

security of term deposits, NSCs eligible for surrender, Indira Vikas Patras
and life policies, where the outstanding are covered by the realizable
value of security, the accounts may be treated as standard assets
TDRS/STDs: Advances there against: These should normally be

considered if the term deposits have already completed 50% of their
maturity period
The advances against gold ornaments and all other kinds of

securities, including Government securities IDBs, NRI bonds are not
covered by this exemption:
Staff A/cs: Staff accounts, including housing loan, consumer loan, and
vehicle loan should be classified as "standards" assets
Festival advance to bank's staff: It is unsecured
Moratorium period: In the case of educational loans, industrial projects,
agricultures plantations, etc., where moratorium is available for payment
of interest, (payment of) interest becomes due only after the moratorium
gestation period is over.
AGL Adv: In respect of agricultural advances, if two seasons (two half-

years) interest/installment was not paid after it had become due, then the
account was treated as NPA (till the year 1995-1996) W.e.f the year
1996-97, in respect of advances granted for agricultural purposes where
interest/installments was in arrears for more than 2 quarters from the date

the interest were due for repayment, the advance was to be treated as NP
A (instead of last two harvest covering two half-years)
In other words, if principal/interest had fallen due for payment before 1ST
October and the same remained unpaid as on 31/03, the account was to be
treated as NPA.
As per the RBI circular dated 04th march 1998, “advances granted for
agricultural purposes may be treated as NP As. If interest of principal
remains unpaid, after it has become past due, for two harvest seasons but
for a period has exceeding two half-years. The guidelines are applicable
W.e.f financial year 1997-98.
In view of recent revision in the guidelines, the branches should fix

realistic repayment schedule in respect of AGL advances taking into
account the marketing sector.
If the borrower- farmers want to wait for opportune time for sale of
agricultural produce, they may be provided appropriate facility/finance
under the produce marketing loan scheme of the bank.
The cash credit facilities under agricultural should be encouraged

and the facilities be provided to all eligible farmers. The due dates of
repayment should be reckoned after allowing reasonable period of say, 2
months for harvesting and marketing for produce (i.e., the farmer is
fluid).
The interest on agricultural advances should be applied on due dates of
loans.

Agl. Adv: Co-op societies: if the account of the co-op. society becomes
NP A, interest to the extent actually realized may be taken to income
account.
Interest should not be charged to income account on accrual basis in
respect of nonperforming assets.
AGL Loans: Affected by Natural Calamities: in respect of cases of

conversion or reschedulement, the term loan as well as fresh short-term
loan should be treated as current dues (and need not be classified as NPA)
Allied AGL Activities: in respect of advances granted for agricultural

purposes, an account should be treated as a non-performing asset if
interest and/or installment of principal remains unpaid after it has become
past-due, for two harvest seasons but for the period not exceeding two
half-years. The relaxation of the norms from two quarters to harvesting
seasons (not exceeding two half-years) is not detailed in earlier
paragraph, are applicable only to the advances for agricultural purposes.
Non-AGL Adv: in the case of non-agricultural term loans, if the

installment/interest for the quarter ending December 1997 remained
unpaid up to 31-3-1998, these are treated as non-performing assets as on
31-3-1998.
Govt.-guaranteed adv.: If govt.-guaranteed advances become "past-due"

and thereby NP A, the interest on such advances should not be taken into
income account unless the interest has been realizes (though the account
may be treated as standard).
The advances guaranteed by the government should be treated as NP A's
only when the

government concerned repudiates its guarantee when invoked.
Allocated Limits: The asset classification is done by allocating branch

and advised to allocated branch.
Rephasement: The rephased/rescheduled advances are classified as sub-

standard assets for atleast two years.
Rephasement of Allocated Loans: when borrower adheres to

rescheduled repayment
programme, interest income can be booked and taken to profit, provided
repayment programme is strictly adhered to. In case of default, extant
instructions relating to income recognition should be followed. The
classification of an asset should be upgraded (from sub-standard to
standard) merely as a result of rescheduling unless the re-
scheduled/rephased advance remains in sub-standard category atleast for
2 years (of satisfactory performance under renegotiated/rescheduled
terms).
Rehabilitation Packages: RBI have decided that provision need not be

made for a period of 1 year from the date of disbursement in respect of
additional facilities sanctioned under rehabilitation packages approved by
BIFR/term leading institutions only (and not other rehabilitation
packages).
PCGC/EBR Assets: Sub-standard & Doubtful Assets: Provisioning

Requirements: Submission of required statements/data/audited certificates

to RO.D at the LHO.
Inspection & Audit: (since asset classification and provisioning affects

the profits of the Bank). The inspecting officials now look into/attend to
various areas relating to these (asset classification of advances,
calculation of provisions, related statements, installments in arrears,
interest arrears, amount held in LN.C a/c, retainable amount of
government guarantee/DICGC/ECGC).
Consortium Advances: in respect of consortium advances, each bank

may classify borrowal accounts according to its own record of recovery of
interest and installments and other aspects having a bearing on the
recoverability of the advances, as in the case of multiple banking
arrangement.
Irregularity for more than 180 days: An account which has become
regular on 3151 March by servicing past interest/installments should be
classified as standard asset even if it remained as irregular during the year
for more than 180 days.
Gujarat Exporters: Bank need not classify as NP A pre-shipment credit

granted to the
exporters where the [period of credit has been extended, or where the pre-
shipment has been converted into short-term credit. the advances should
be treated as NP A if the interest of installment remains unpaid for two
quarters after it has become past-due taking into account the revised due
dates fixed by the banks after extension of the period or conversion of the
pre-shipment credit, as the case may be. The above relaxation in asset

classification is applicable only to the exporters affected by the cyclone

of Gujarat.
Temporary Irregularities: The banks should not classify an advance

account as NP A merely due to its existence of some deficiencies, which
are temporary nature such as:
-Non -availability of adequate drawing power temporarily.
-Balance outstanding exceeding the limit temporarily;
-Non-submission of stock-statements, and
-Non-renewal of the limits on due date, etc.
However, when there is a threat of loss or recoverability of the

advance is in doubt, the asset should be classified as NPA. (since
identification of NPA is done on the basis of the position as on the date of
the balance sheet), advances which have been regularized by the
repayment of outstanding interest or installment of principal before the
balance sheet date may not be treated as NPA, even though default in the
accounts might have persisted for 2 quarters or for major part of the year.
If the accounts of the borrowers have been regularized before the
balance sheet date by repayment of overdue amounts through genuine
sources (not by sanction of additional facilities solely for the purpose of
regularizing the accounts or transfer of funds between accounts), the
accounts need to be treated as NP A.
Potential Threats: in respect of accounts where there are potential

threats of availability of security and existence of other factors, such as
frauds committed by borrowers, the accounts should be straightaway
classified as doubtful assets or loss asset, as appropriated, irrespective of

the period for which it has remained as NP A (i.e., without waiting for a
period of 2 years, etc)
PROVISIONING:
(a) No provision on interest not collected and unrealized interest of

previous year (W.e.f. the year 1994-95).
(b) 100% provision in respect of loss assets.
(c) Outstanding below Rs. 25000/- (earlier classified under health 1 to 3):
For the year 1993-94, the banks were required to make provisions to the
extent of 5% of the aggregate amount outstanding in respect of advances
with balances less than Rs. 25000/- while making this provision, the
value of security and amount guaranteed by DICGC/ECGC was not
deducted from amount of advance. Banks are, however, free to make
provisions in respect of these advances as per the norms for other
advances (Le., advances for Rs. 25000/- and over)-, as is being done by
SBI. (Small loans, i.e., loans with outstanding up to Rs. 25000/- from
10% of banks advances; atleast 40% of these assets are non-performing.
(d) Calculation of provision in respect of advance accounts covered by
guarantee:
the existing stringent method should continue to be followed
(e) Retainable amount of DICGC claim should be calculated assuming
that all future recoveries as and when securities charged to the bank are
realized are required to be shared. For sub-standard assets, provision
computation is now based on outstanding in the account.
Doubtful assets: The security value multiplied by % of DICGC cover or

claim amount received whichever is lower, should be deducted from

tangible assets value for calculating ad-adhoc provision @ different rates

on secured value in an account having DICGC/ECGC guarantee.
INTEREST NOT COLLECTED A/C:
a) A new General Ledger A/C - interest not collected a/c- has been
opened for NPAs.
b) Interest debited to borrowers accounts classified, as NP As not realized
is required to be debited to interest Ale and credited to this account.
c) Till the year 94-95, no further interest could be debited to such
accounts unless all past arrears of interest were collected
d) Balancing: monthly
e) Proforma register
Products: The daily products should be regularly

calculated/struck/extended in all NP A accounts held in live
ledgers where operations are permitted.
Register: the interest due on such NP A accounts should be carried

over to a separate register (so that the borrowers overall liability
could be ascertained at any given point of time. This also facilities
charging and recovering correct amount of interest due from
borrowers)
Drawing power: where the operations in the NPA accounts are

permitted, effective steps should be taken to regulate the drawing
power in view of the accrued but unapplied interest while allowing
drawings in the CCIOD account, this factor should also be taken
into account.

As and when credits are received on a/cs identified as NP A:
Till 1994-95, such credits could be reversed to debit of 'interest not

collected account only if the borrowal accounts became performing
assets. Otherwise, the credits were to be left undisturbed.
I.N.C.: clarifications: all advances are now required to be classified as

non-performing assets only as on the balance sheet i.e., 31st march each
year.
In respect of all the accounts classified as standard assets as on the
31.03.1997, interest application should be continued till 31.03.1998 only.
As soon as the non-performing asset becomes a performing asset, the

entire amount parked in I.N.C. a/c in respect of the unit should be
reversed by debit to I.N.C. a/c and credit to interest a/c. recoveries
effected should, however, be routed through the borrowers account.
Partial recovery of the dues:

The amount of interest parked in I.N.C. a/c can now be recovered
as per the details furnished separately.If the status of the advance changes
to NPA on 31.03.1998 due to non-recovery, the amount of interest
booked by debit to party's account and credit to inte
rest account should be
reversed by debit to interest account and credit to I.N.C. a/c on
31.03.1998 only. Application of interest as from 01.4.1998 should be
stopped till such time such time the status again changes.
I.N.C. ale: further clarifications: at no point of time, transfer of amounts

from I.N.C. a/c to accounts in live ledger is envisaged.Transactions in

I.N.C. account should continue to be only between interest a/c and I.N.C.
a/c.
Procedure for operations on I.N.C. a/c:
All transactions involving I.N.C. alc are required to be put through

by using composite vouchers showing the accounts between which
the amounts are transferred. (This prevents movements of
balances from I.N.C. a/c to borrowers account- except at the time
of write-off where the balance is transferred to the PB a/c of the
borrower- or to any other account by mistake or by design)
The composite vouchers are required to be passed only by the
BM/Manager of the division.
Wherever, concurrent auditors are posted, they are required to
verify invariably all transactions passing through I.N.C. a/c with
emphasis to I.N.C. a/c.
I.N.C.: 'Current' years unrealized interest: it is required to be held by the

branches in I.N.C. a/c. W.e.f the year 94-95 the 'previous year's interest is
required to be provided for at the apex level by creating provision in the
books of CAO. Unrealized interest of "previous year" is shown in the
yearly return of advances.
'Current' year means the year when an account is identified as NP A for

the first time;
'Previous' year means the year previous to the year when it is first
identified as an NPA
account.

For an account, which became NPA for the first time in 1994-95, the
current year is 1994-95 and previous year is 1993-94.
I.N.C: Recoveries: to compute unrealized interest of 'previous' year, RBI

has taken into account the recoveries made during the year of
identification towards "previous year" interest.
I.N.C. a/c: Reversal: in an account having I.N.C. in excess of out
standings and where no
further drawings are permitted, the difference between I.N.C. and out
standings can be reversed and credited to interest a/c.
Writing offs: if the NPA is actually written off the LN.C. a/c out
standings pertaining to that account should be transferred to respective
PB a/c (as LN.C. is treated as a provision and accordingly utilized for
write off)
Strategies: branch functionaries should get in touch with the concerned

borrowers and build up maximum pressure to affect recovery as quickly
as possible. Recovery drives, recovery camps, door-to-door calls etc
should also be initiated.
A quick ABC analysis (Always Better Control) should be done of
large-value C&I/SSI advances where interest is in arrears; these should be
chased on priority basic with a view to achieving the best results.
Other incomes: all other incomes (i.e., other than interest) viz exchange,
commission, discount, etc are not covered by IRAC norms.

PRUDENTIAL NORMS FOR AGRICULTURAL ADVANCES:
In order to align the repayment dates with the harvesting of crops,

the reserve bank has decided that with effect from September 30, 2004
the following revised norms would be applicable to all direct agricultural
advances
A loan granted for short duration crops would be treated as NP A, if the
installment of principal or interest thereon remains overdue for two crop
seasons.
A loan granted for long duration crops would be treated as NP A, if the

installment of principal or interest thereon remains overdue for one crop
season.
For the purpose of these guidelines, "long duration" crops would be crops
with crop seasons longer than one year and crops, which are not "long
duration" crops would be treated as "short duration" crops.
The crops season for each crops, which means the period up to harvesting
of the crops raised, would be as determined by the state leave banker's
committee (SLBC) in each state.
Depending upon the duration of crops raised by an agriculturist, these NP
A norms would also be applicable to agriculture term loans availed of by
him. In respect of agriculture loans, other than those specified in the
reserve bank's master circular of august 2003 and term loans given to
non-agriculturists identification of NP As should be done on the same
basis as non-agricultural which, at present, is the 90 days delinquency
norm.
Banks are urged to ensure that while granting loans and advances,
realistic payment scheduled are fixed on the basis of cash flows/fluidity
with the borrowers. This would go a long way to facilitate prompt

repayment by the borrowers and thus improve the record of recovery in

agricultural advances.
NPAs additional provisioning:
At present, banks are required to make provision on NP As on a

graded scale based on the age of the NPA. However, in respect of NPAs
included in doubtful for more than three years' category, the provisioning
requirements on the secured portion remains unchanged at 50%,
irrespective of its age, till it is identified as a loss asset. With the
enhancement of the Securitization and reconstruction of financial assets
and enforcement of security interest act, 2002 and the chances/extent of
recovery of an asset reducing over a period of time, it is essential that
bank expedite recovery of NPAs.
The reserve bank has decided to introduced graded higher

provisioning according to the age of NPAs in doubtful for more than3
years category with effect from march 31, 2005.consequently the increase
in provisioning requirement on the secured portion would be applied in a
phased manner over a 3 years period in respect of the existing stock of
NP As classified as doubtful for more than 3 years as on march31, 2004.
However, in respect of all advances classified as "doubtful" for

more than 3years on or after April 1, 2004 the provisioning requirement
would be 100%. Accordingly, the provisioning norm for advances
identified as 'doubtful for more than three years would be indicated below
with effects from March31, 2005
Unsecured portion: The portion of the advances which is not covered by

the realizable value of tangible security to which the bank has a valid
resources and the realizable value is estimated on a realistic basis,
provision would be to the extent of 100% as hitherto.
Secured portion:
Period for which the advances has Provision requirement on

remained secured portion
in ‘doubtful’ Category more than three
years
Outstanding stock on NPAs as on 60 % as on march 31st 2005
March 31st 2005 75% as on march 31st 2006
100% as on march 31st 2007
Advances classified as “doubtful for 100%
more than three
Years” on or after April 1 st 2005
Banks have been advised to make suitable provision during the current
year to ensure a smooth transition to the revised norms, which would
become effective from March31, 2005.
WITHDRAWALS OF LIMITS ON UNSECURED EXPOSURES
In order to extend further flexibility to banks on their loans

policies, the reserve bank has decided that their own policies on
unsecured exposures. All exemptions allowed for computation of
unsecured exposures also should be withdrawn.

Banks should make an additional provision of 10 per cent ,i.e., a total

provision of 20 per cent of the total outstanding advances in the sub-
standards category to cover expected loss on unsecured exposures.
Provisioning at the level of 100 per cent for unsecured exposures in

doubtful and loss categories would continue as hitherto.
Definitions:
With a view to ensuring uniformity in approach and implementation,
'unsecured exposure" is defined as an exposure where the realizable value
of the security, as assessed by the bank/approved valuers/reserve bank's
inspecting officers is not more than 10 percent, ab-initio, of the
outstanding exposure.' exposure' shall include all funded exposures.
'Security' means tangible security properly charged to the bank and does
not include intangible securities like guarantees, comfort letters, etc.
Gross NP A:
Gross NP As is the amount outstanding in the borrowal accounts, in book
of the bank other than the one, which has been recorded and not debited,
to borrowal accounts.
Net NPA:
Net NP As is the amount of gross NPAs less
(a) Interest debited to borrowal and not recovered and not recognized and
kept in interest suspense,
(b) Amount of provisions held in respect of NPAs and
(c) Amount of claim received and not appropriated.

CAUSES OF NON PERFORMING ASSETS
Though the balance sheets are silent on details like the reasons for
or the sector responsible for the NPAs, a close analysis of the banking
system suggest that the problem of NPAs have its origin in both external
and internal factors.
External Factors:
1. Legal Bottlenecks:
The problem of NPAs has sizeable overhang component arising

from infirmities in the existing processes of debt recovery, inadequate
legal provisions on foreclosure and bankruptcy, difficulties in execution
of court decree and long drawn legal procedure.
The fact that even the newly established private sector banks in
spite of their efficiency in many respects have been hit hard by the
malady of NPA is a testimony enough of the inadequacy of the current
Indian legal system in protecting the lender'sinterest.
2. Loan to Priority Sector:
An important point to note is that a large chunk of the NPA is

dispersed among the millions of priority sector loan accounts at different
corners of the country. In fact as a percentage of total priority sector
advances the share of NPA in this sector is frighteningly high at 45.43
percent in PSBs and at 33.08 percent in Old Private Sector Banks.
Evidently banks took little precaution while rating loans under various
directed credit programmes. The factors which have led to the current
sorry state in respect of priority sector NPAs are:

• Vitiation of loan repayment culture consequent to loan waiver

schemes.
• Directed and pre-approved nature of loans sanctioned under
sponsored programmes.
• Absence of any security or any follow-up due to large number of
accounts.
• A widespread feeling that these loans were grant.
3. General Economic Conditions:
The incidence of NPAs is also related to the external environment

and the state of the economy. The external environment is not conducive
to enterprises. Also factors such as lack of adequate infrastructure, slow
and unsympathetic decision-making in Government agencies are
affecting the profitability and viability of enterprises. So there is a need
for banks to have a very pro-active policy of nursing and rehabilitating
the weak units or those under temporary strain.
4. Corporate Defaulters:
Closely linked to the issue of NPAs is the diversion of funds by

promoters (corporates) One of the aspect of the willful default is
promoters tunneling i.e., diverting money to group companies over which
they have greatest control. According to data collected by bank unions
from the RBI, members of the country’s apex chamber of commerce and
industry account for around 70 per cent of total NPAs. Members of the

high profile CII were responsible for almost 41 per cent of total gross
NPAs amounting to Rs. 25000 crore.
Internal Factors:
Quite often, the seeds of NPAs are sown at the very first stage,
project appraisal. While banks pore over an application for months, the
quality of appraisal leaves much to be desired. Banks should not totally
rely on the information given by the applicants but they should carry out
an independent appraisal. This would curtail the wide scale occurrence of
NPAs in future. In most PSBs training facilities are not adequate to meet
the training requirement of the staff of the bank. Also motivation and
morale of employees is generally low.
MEASURES
The magnitude of the problem and the reasons behind it call for
immediate corrective steps in the recovery processes so that the problem
is contained. The recovery plan should take long-term measures to dig out
the roots of this problem. But the impact of the problem on the current
scenario should not be totally neglected. The week banking system is also
contributing to the current crises. Thus, some immediate medium-term
measures should also be taken.
Long-term measures
Legal Corrections: The most important long-term measure in the

direction to contain the growth of this malaise in future is legal reforms.
In this direction the pending legislations on bankruptcy or foreclosure
should be expeditiously implemented. And necessary amendments should

be made in the existing legislations. It will make recovery processes

smother and legal action quicker.
The issue of legal reform would assume greater importance as

economic liberalization gains momentum. The continual state of
innovation of the new financial products in the liberalization process
would outpace the existing legislations.
Proper Credit and Risk Assessment Mechanism: Lasting solution

to the problem of NPAs can be achieved with proper credit assessment
and risk management mechanisms. For instance in the situation of
liquidity overhang, the enthusiasm of the banking system to increase
lending could compromise on asset quality, raising concern about adverse
selection, and potential danger of addition to the stock of NPAs. It is,
therefore, necessary that the banking system is equipped with prudential
norms to minimize, if not completely avoid the problem. RBI is taking
the necessary steps in this direction.
Redefining Priority Sector: In many countries directed credit gave rise

to large NPAs adversely affecting the viability of banks. As discussed
above, in India also, it’s the same case. But directed credit cannot be
totally erased because of development concerns of certain core sectors.
However, its scope can be limited and relaxation given to the priority
sector can be reduced. This would bring in a sense of responsibility in the
priority sector units and improve their financial viability. Thus,
considering the basic merit of social banking vis-à-vis ensuring sound
banking practices, the priority sector should be redefined.

Internal Reforms
As regards internal factors leading to NPAs, the onus rests with

the banks themselves. This calls for organizational restructuring,
improvement in managerial efficiency, skill up gradation for proper
assessment of creditworthiness and a change in the attitude of the banks
towards legal action, which is traditionally viewed as a measure of the
last resort.
Beside the above mentioned long-term measures the banks are

being provided with the following menu of medium term measures like
Asset Reconstruction Company, Corporate Debt Reconstruction and
Compromise Settlement Procedure. But the following problems would
arise with these measures:
1. The approach of the solutions like Corporate Debt Reconstructing

and Compromise Settlement Procedure would be very
individualistic and as a result their scope would also be limited.
These measures would also not be able to cut NPAs from the banks
in the medium-term. Thus the focus of the banks would be diverted
from their core business and their resources would be channelised
in managing NPAs. This would in turn also hamper the profit
earning capacity of the banks.
2. With regard to Asset Reconstructing Company the government
would have to create Asset Reconstruction Funds immediately at
the time of separation of the NPAs from the banks. This would put
huge strain on the government at a time when it is finding it
difficult to control its burgeoning fiscal deficit. and the government
would have to postpone this issue for the time being.

Above deficiencies makes it imperative to look for the medium term

measure, which is- on one hand immediately separate NPAs from the
banks and on the other hand do not bring immediate financial strain on
the government. This leads us to the process of SECURITIZATION of
assets.
However before looking into securitization as a medium term solution

to the NPAs problem it would be prudent to look into the various
restructuring exercise taken up internationally to correct the banking
problems.

INTRODUCTION TO SECURITISATION ACT 2002
The need for the setting up an asset reconstruction company for

acquiring distressed assets from Banks and Fls with a view to develop
market for such assets was being felt, since long. Narasimham Committee
1 &2 and the Verma Committee on restructuring of weak Banks has
strongly recommended the setting up of Asset Reconstruction Companies
(ARCs)
The business of Securitization and Reconstruction is primarily meant for

more than one purpose:

To regulate the business of securitization and reconstruction of the
financial interest

To regulate enforcement of the security interest and for the matters
connected therewith or the matters incidental thereto
The debt securitization is a new concept in the Indian financial markets

and is primarily meant for enhancing the liquidity of the Banks and Fls
which have extended financial assistance to the borrowers for various
purposes.
The debt securitization makes available with these institutions the
security papers against the financial assets which have been created out of
the financial assistance sanctioned and disbursed by these institutions and
in the case of a default by the borrowers the secured creditors can have a
recourse to either the securitization of the financial asset or the
reconstruction of the same.

What is Securitization?
Securitization is a process whereby the 'originator' of the various

financial assets including loans which are illiquid can transfer such assets
to special purpose vehicles(SPV) which issues the tradable securities
against these loans and these are issued to the investors.
It is an acquisition of financial asset by any securitization company from

the 'originator' whether by raising of funds by such securitization
company from 'qualified institutional buyer' or by issue of security
receipts representing undivided interests in such financial assets or
otherwise.
Thus, there will have to be some sort of understanding between the

OIBs and the securitization company which can be 'originator' in the case
of the banks and the Fls which has extended the financial assistance to the
'ob
ligor' who is supposed to repay the financial assistance ininstallments
on some future dates as per the agreement entered into by it with the
bank. This can be referred to as the 'security agreement. It is an
instrument or any other document or arrangement under which the
'security interest' is created in favour of the secured creditors including
the creation of the mortgage by the deposit of the title deeds with the
secured creditors.
Objectives of Securitization
There are two basic objectives of securitization:

To reduce the assets of the originator to reduce the capital
requirement


To achieve the reduction in demand and time liability.
Once the assets go off the balance sheet the originator can thus reduce
his capital requirement, similarly on the liquidation of the assets the need
for the time assets and the demand liability comes down as these are
subject to the statutory reserves.
Securitization as financial product
Securitization is considered as financial product and the bonds/debentures

can be issued based on the future installments against the financial
assistance already sanctioned and disbursed by the banks and financial
institutions.
Some important terms on the concept of securitization:
1. Qualified Institutional Buyer: It can be a financial institution, insurance
company, banks, state financial corporation, state industrial development
corporation, trustee or any asset management company making
investment on behalf of any mutual fund/ provident fund/gratuity
fund/pension fund or any foreign institutional investor which may have to
be registered with the SEBI or any other corporate body which can be
specified by SEBI.
2. Originator: The bank or the FI which offers the product is referred to as

the originator.
3. Obligor: The client whose future installments are securitized is referred

to as the obligor (borrower).

4. Security receipt: is a receipt or any other security issued by a

securitization company to a QIB pursuant to a scheme, evidencing the
purchase or the acquisition by the holder thereof, of an undivided right,
title or interest in the financial asset involved in the process.
5. Security agreement: An agreement, instrument or any other document or

arrangement under which security interest is created in favour of the
secured creditor including the creation of the mortgage by the deposit of
the title deeds with the secured creditors.
6. Security asset: means the property on which the security interest is

created.
7. Secured creditor: Includes any bank or financial institutions or any

consortium or groups of banks and financial institutions.
8. Secured debt: means a debt which is secured by any security interest.
9. Secured interest: means right, title and interest of any kind, whatsoever
upon the property, created in favour of any secured creditor and includes
any mortgage, charge, hypothecation, assignment etc.
10. Sponsor: means any person holding not less than 10% of the paid-up
equity capital of a securitization company or reconstruction company.
11. Borrower: means any person who has been granted financial
assistance by any bank or Fls who has been given any guarantee or
created any mortgage/pledge as security for the financial assistance
granted by any bank or FI.

12.Default: means non payment of any principal debt or interest thereon

or any other amount payable by a borrower to any secured creditor
consequent upon which the account of such borrower is classified as
'NPA' in the books of account of the secured creditor in accordance with
the directions/guidelines issued by the RBI.
13. Financial Assistance: means any loan or advance granted or any

debentures or bonds subscribed or any guarantees given or letters of
credits established or any other credit facility extended by any bank or FI.
14. Financial Asset: means debt or receivable and includes:
A claim to any debt or receivable or part thereof, whether secured

or not.
Any debt or receivable secured by mortgage of or charge on
immovable property.
Mortgage, charge, hypothecation or pledge of immovable property.
Any right or interest in the security whether full or part underlying
such debt or receivable.
Any beneficial interest in property, whether immovable or movable
or in such debt, receivable whether such interest is existing, future
or accruing, conditional or contingent.
Any financial assistance.
The process of securitization
The' bank sanctions and disburses the financial assistance to the

borrower for the purpose of setting up a project or for the expansion or

for the purpose of diversification. As per the agreement between the

above two parties the amount of financial assistance will be repaid by the
borrower to the bank in installments along with the interest at the rate
specified at the time of sanction. The borrower offers the various assets as
security with the bank for this purpose.The bank is thus the secured
creditor and has the necessary charge on the property of the borrower
which invariably would be a company. The bank intends to sell the
installments which will fall due on the loan as they might be in need of
the funds at some point of time before the actual due dates. It is at this
point of time that the process of securitization comes into picture.
1) The bank intends to increase its liquidity on the strength of the amount
of the loan already disbursed to the borrower.
2) The bank will enter into an agreement with the Qualified Institutional
Buyer (QIB) for the purpose of disposing the asset securitized by it.
3) The bank has to analyze its portfolio of the debts due and try to
classify the dues/borrowers who will be in a position to pay the dues on
time. The essence is that the entire installments which are proposed to be
sold to the QIB should be repaid with 100% surety level or else the deal
may not fructify.
4) The bank converts these installments into suitable forms of
bonds/debentures as may be required by the QIB
5) The nature of security, duration, the amount and the rate of interest etc
has to be discussed at length and the deal will mature only if it fulfils the
need of the QIB and the 'originator'.
6) The borrower is not affected financially or technically by the decision,
He may be required to comply with certain formalities.
Diagrammatic representation of the process of securitization

Borrower
Bank /financial “Obligor”
institution
“originator’ Financial assistance
sanctioned
QIB pays Security created by the ‘obligor’ in

the favour of the ‘originator’
‘originator’
through the
securitizatio
n company Bonds / debentures issued by the ‘originator’
to the QIB against the future installments to be
received from the ‘obligor’
In practice there would be a securitization company to undertake

the job of issue of bonds/debentures by first acquiring the financial assets
of the banks i.e. .obligor". The following diagram illustrates the role of
Securitization Company.
Diagrammatic representation of the role of the securitization company
Qualified institutional
buyer
Securitization
Company
The originator
It may be observed from the diagram that the securitization

company is a sort of intermediary company between the bank and the

qualified institutional buyer. The bank intends to sell its financial assets
to the securitization company which in turn arranges the buyer of the
asset.
There may be two specific occasions when the need for the securitized
asset and its transfer may be necessitated so far as the 'originator' is
concerned:

To increase its liquidity

To handle the non performing assets (NPAs) effectively
The Securitization and Reconstruction of Financial Assets and

Enforcement of Security Interest Act, 2002 popularly called the
Securitization Act has provided an enabling legal framework for the
setting up of securitization or reconstruction company and the manner of
acquisition of financial assets by such companies.
Commencement of the Act

The Act has been made effective from 21st June 2002, the date on which
the first securitization and reconstruction of financial assets and
enforcement of security interest ordinance, 2002 was promulgated.
This Act has been enacted to help Banks and Fls to tackle the NPA
problem. This Act can be broadly divided into four heads:
¾
Securitization of assets
¾
Enforcement of security interest

¾
Setting up of Central Registry
¾
Establishment of an ARC
The two terms which have been used in the Act which are of special
significance are:
The security Interest

Financial Asset
The Act has explained these two terms in section 2(1) (zf) and 2(1 )(L)
as:
'Security Interest'
means right, title and interest of any kind whatsoever
upon property, created in favour of any secured creditor and includes any
mortgage, charge, hypothecation, assignment other than those specified in
section 31.
'Financial Asset'
means debt or receivable and includes-
A claim to any debt or receivables or part thereof, whether

secured or unsecured.
Any debt or receivables secured by, mortgage of, or charge on,
immovable property
A mortgage, charge, hypothecation or pledge of movable
property
Any right or interest in the security, whether full or part
underlying such debt or receivables
Any beneficial interest in property, whether movable or
immovable, or in such debt, receivables, whether such interest is

existing, future, accruing, conditional or contingent

Any financial assistance.
Purpose of the legislation
Our existing legal framework relating to commercial transactions

has not kept pace with the changing commercial practices and financial
sector reforms. This has resulted in slow pace of recovery of defaulting
loans and mounting levels of non-performing assets of Banks and Fls.
Narasimham committee 1 &2 and Andhyarujina Committee constituted
by the Central government for the purpose of examining banking sector
reforms have considered the need for changes in the legal system in
respect of these areas. These committees, inertia, have suggested
enactment of the said Act for the securitization and empowering banks
and Fls to take possession of the securities and to sell them without the
intervention of the court.
The provisions of the ordinance would enable banks and Fls to:

Realize long-term assets

Manage problem of liquidity

Manage Asset-Liability mismatches and

Improve recovery
These could be achieved by exercising powers to take possession of

securities, sell them and reduce NPAs by adopting measures for recovery
or reconstruction.

Provisions/Highlights of the Act
The Securitization Act contains provisions to provide for the following:
a) Registration and regulation of securitization companies or

reconstruction companies by the Reserve Bank of India(RBI)
b) Facilitating securitization of financial assets of banks or reconstruction

with or without the benefit of underlying securities
c) Facilitating easy transferability of financial assets by the Securitization

Company or reconstruction company to acquire financial assets of banks
and Fls by issue of debentures/bonds or any other securities in the nature
of a debenture
d) Empowering securitization companies/reconstruction companies to raise

funds by issue of security receipts to qualified institutional buyers
e) Facilitating reconstruction of financial assets acquired by exercising

powers of enforcement of securities or change of management or other
powers which are proposed to be conferred on the banks and Fls
f) Declaration of any securitization company or reconstruction company

registered with the RBI as a public financial institution for the purpose of
section 4A of the Companies Act, 1956.
g) Defining "security interest as any type of security including mortgage and

charge on immovable properties given for due repayment of any financial

assistance given by any bank or Fls.
h) Empowering banks and financial institutions to take possession of

securities given for financial assistance and sell or lease the same or take
over management in the event of default, i.e. classification of the
borrowers account as NPA in accordance with the directions given or
under guidelines issued by the RBI from time to time
i) The rights of a secured creditor to be exercised by one or more of its

officers authorized in this behalf in accordance with the rules made by the
Central government
j) An appeal against the action of any bank or Fls to the concerned Debt
Recovery Tribunal and a second appeal to the Appellate Debt Recovery
Tribunal
k) Setting up or causing to be set up a Central Registry by the Central

government for the purpose of registration of transactions relating to
securitization, asset reconstruction and creation of 'security interest'
I) Application of the proposed legislation initially to banks and Fls and

empowerment of the Central government to extend the application of the
proposed legislation to non-banking financial companies and other
entities
m) Non- application of the proposed legislation to security interests in

agricultural lands, loans not exceeding Rs. 1,00,000 and cases where 80%
of the loans are repaid by the borrower.

Transactions not covered by the Act
The provisions of this Act shall not apply to:

a) A lien on any goods, money or security given by or under the Indian
Contracts Act 1872(9 of 1872) or the Sale of Goods Act, 1930(3 of
1930)
or any other law for the time being in force.
b) A pledge of movables within the meaning of the section 172 of the
Indian
Contract Act, 1872(9 of 1872).
c) Creation of any security in any aircraft as defined in clause(1) of
section 2
of the Aircraft Act, 1934(24 of 1934)
d) Creation of security interest in any vessel as defined in clause(55)of
section3 of the Merchant Shipping Act, 1958(44 of 1958)
e) Any conditional sale, hire purchase or lease or any other contract in
which
no security interest is created
f) Any rights of unpaid seller under section 47 0 the Sale of Goods Act,
1930(3)
g) Any properties not liable to attachment or sale under the first
provision to
sub- section (1) of section 60 of the Code of Civil Procedure, 1908(5)
h) Any security interest for securing repayment of any financial asset
not
exceeding one lakh rupees.
i) Any security interest created in agricultural land
j) Any case in which the amount due is less than 20% of the principal

amount an interest thereon.
Protection of action taken in good faith-

No suit, prosecution or other legal proceedings shall lie against any
secured creditor or any of his officers or managers exercising any of the
rights of the secured creditor or borrower for anything done or omitted to
be done in good faith under the Act.
Civil court not to have jurisdiction----

No civil court shall have jurisdiction to entertain any suit or proceedings
in respect of any matter which a Debt Recovery Tribunal or the Appellate
Tribunal is empowered by or under this Act to determine and no
injunction shall be granted by any court or other authority in respect of
any action taken or to be taken in pursuance of any power conferred by or
under this Act or under the Recovery of Debts Due to Banks and
Financial Institutions Act, 1993(51)
The provisions of this Act to override other laws--

The provisions of this Act shall have effect, notwithstanding anything
inconsistent therewith contained in any other law for the time being in
force or any instrument having effect by virtue of any such law.
Limitation----
No secured creditor shall be entitled to take all or any of the measures
under sub-section(4) of section 13, unless his claim in respect of the
financial asset is made within the period of limitation prescribed under
the Limitation Act, 1963(36)
Application of other laws not barred----

The provisions of this Act or the rules made there under shall be in
addition to, and not in derogation of, he Companies Act, 1956(1), the
Securities Contracts Act, 1992(42), the Securities and Exchange Board of
India Act,1992(15), the Recovery of Debts Due to Banks and Financial
institutions Act, 1993(51) or any other law for the time being in force.
Certain provisions of this Act to apply after Central Registry is set up

or
caused to be set up----'
The provisions of sub-sections (2),(3) and (4) of section 20 and sections
21,22, 23, 24, 25, 26 and 27 shall apply after the Central Registry is set
up or caused to be set up under sub-section(1 O)of section 20.
No Asset Reconstruction Company or Securitisation company can
commence or carry on the business of Asset Reconstruction or
Securitisation
Without obtaining a Certificate of Registration to be granted under
section
3 of the Securitisation Act, 2002
Without having owned funds of not less than Rs.2 crore or such
other
amounts not exceeding 15% of total financial assets acquired or to
be
acquired by such company, as the RBI may notify.
All ARCs or Securitisation companies, which are in existence on the
commencement of the Act, shall make application for registration to RBI
before the expiry of 6 months from such commencement.
All ARCs are to be regulated and registered with the RBI. There will be a
Central Registry and Central Registrar, to whom details of all individual

transactions are to be reported, on an on-going basis
PURPOSE OF REVIEW OF LITERATURE
The purpose of review of literature was to identify the problem statement,

understand the secondary data that has been gathered in this field of study
and to make new findings on the problem statement.
METHODOLOGY OF THE REVIEW OF LITERATURE
Methodology of literature review encompasses different facets of

information sources concerning Non-performing assets and the
Securitisation Act
Sources of information for the literature review are as follows

Banking magazines

Internet

Newspaper publications and articles.
Securitisation Act 2002- Revolution in waiting
By Anupam Srivastava!
(Advocate)
The last one decade has seen vigorous attempts on the part of the
legislature to enact a law which could effectively curb the menace of ever
growing Non Performing Assets, which today stand at more than Rs
1,00,000 Crores. The Civil Courts were not found effective, hence came

the Recovery of Debts Due to Banks and Financial Institutions Act, 1993
(RDDBFI Act). The desired results did not come from this Act, hence
came The Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 (Securitisation Act). The big
question is Whether the Securitisation Act is likely to improve the
banking recovery?
Securitisation Act w.eJ. 21st day of June 2002, lays the emphasis on
recovery of the money, even without the intervention of Court. The
Banks were empowered under Section 13(4) of Securitisation Act to take
possession of Secured Assets of the Borrower including the right to
transfer by way of lease, assignment or sale for realizing the Secured
Asset. The role of the Court was limited to challenge the measures under
Section 13(4), by way of Appeal, that too on deposit of 75% of amount
claimed on the notice under Section 13(2) of Securitisation Act.
In effect the Securitisation Act, 2002 did away with the first aspect of
recovery of dues i.e. ascertainment of dues but concentrated only on the
second aspect i.e. executing the decrees. The first aspect was put to
impossible conditions for challenge like pre-deposit of 75% of amount
ascertained by the Banks & not Courts of law. The result of which is
Hon'ble Supreme Court in Mardia Chemicals Vs. The Union of Indial
strikes down the condition for deposit as ultra vires of the Constitution,
which make_ _he Securitisation Act, 2002 almost redundant for recovery
of dues.
By March 31, 2003 the banks and financial institutions had issued
about 28,886 notices to the defaulters involving an amount of Rs 10,171
Crores. The total amount recovered till the end of March 2003 was only
Rs 440 Crores. The figures till June, 2003 improved only by Rs 59 crores,

raising the amount recovered to Rs 499 Crores 2 , accounting for just 4.1
% of the total outstanding amount for which the notices were issued. This
indicates banks may have succeeded in capturing small fishes, Sharks are
still at large.
SC verdict on Securitisation Act - More bark than bite?
By Padmalatha Suresh
Bankers abhor them. Balance-sheets detest them. Borrowers (at least

most of them) do not want to be part of them. They are those dreaded
three letters, NPA, standing for 'Non Performing Assets', euphemism
used to describe difficult-torecover bank loans.
Therefore, when the Supreme Court upheld the constitutional validity of

the Securitisation and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 (the Securitisation Act) on
April 8, bankers breathed a sigh of relief. The ruling would allow banks
and financial institutions to take possession of the security given by the
defaulting borrowers and sell these assets without having to go through
protracted legal procedures.
The court, however, ruled as unconstitutional the provision that required

aggrieved borrowers to make an upfront deposit of 75 per cent of the dues
claimed in case they preferred to go on appeal against the lender's action.
The salient provisions of the Securitisation Act state that the lender can
take possession of the asset in case the borrower does not discharge his
liabilities within 60 days of the demand notice from the lender. The
lender can then manage the assets with a right to transfer them by way of

lease, assignment or sale.
Are banks today equipped for this? Imagine banks having thousands of
such seized assets of various descriptions and values in their physical
possession. The sheer cost of maintaining such assets in marketable form
could be formidable.
Borrowers would know that their assets are in jeopardy if they do not
deliver on their promises or take the lenders into confidence in respect of
their business risks. The change would be in the attitude. And this change
would go a long way in enhancing the quality of the banking system's
asset
The Securitisation Act aims to achieve two objectives: Make adequate
provisions for the recovery of loans and also to foreclose the security.
The Act was welcomed by the banking community, but resisted by the
borrower community. Understandably so. The validity was challenged in
various courts on the ground that it was predominantly in favour of
lenders. Hence, lenders were unable to enforce the provisions in full.
Securitisation-will they Act
By Hindustan times.com
Some in India Inc. may have had a bad year, thanks to the Securitisation
Act but almost all top bankers and financial institution honchos
experienced relief with the passing of this Act. Having got armed under
the Act to take possession of the assets of defaulters, the past few weeks
saw several banks send notices to defaulters for recovery of their sticky
assets. Be it a hotel, a factory, office or residential premises, defaulters

long habituated to making merry on borrowed money are already finding

the going tough. The new Act is expected to arrest the mounting NPAs
and help banks improve their bottomlines.
MCCI welcomes Securitisation Act
THE Madras Chamber of Commerce and Industry (MCCI) has spoken in

a refreshingly different voice, from that of most others in the industry. It
has welcomed the Securitisation and Reconstruction of Financial Assets
and Enforcement of Security Interest Act, 2002, (or, the Securitisation
Act), calling it "a step in the right direction".
In a note, the chamber has said: "The fact is, not all businesses succeed
and when a business does not succeed, the only exit available for the
lender is to securitise the assets and claim those margins, which protect
the money lender".
At a press conference in Chennai, one member did point out a "practical

difficulty" in a bank taking over a piece of hypothecated machinery and
its ability to protecUseU it, but agreed that this question did not come up
with the Securitisation Act - it was there even before.
Chances of NP A recovery in banking limited
By Rajarshi Roy and Partha Sinha
(Times of India, Bangalore, June7, 2004)
Chances of recovery of NPAs in the Indian financial system, which

amounted to a staggering Rs.89, 900 crore as of March 2003, are limited,

a recent technical report to the Ministry of Finance has said.
The technical assistance report as initiated by the Asian Development

Bank for the Ministry of Finance and prepared by Price-waterhouse
Coopers along with two law firms Amarchand Mangaldas& Suresh
A. Shroff& Co, and Blake
Dawson Waldron.
The project's objective was to review the Indian NPAs and the existing
legal and operational framework for the Asset Reconstruction
Companies(ARCs), including the Securitisation and Reconstuction. of
Financial Assets and Enforcement of Security Interest Act 2002, and to
recommend suitable changes for effective functioning of ARCs in India.
The report pointed out that around 23% of the NPAs were in priority
sectors like agriculture and small scale industries activities like retail
trade loans to professional and self-employed persons, housing and
education loans, microcredit etc. It was found in the survey that 48% of
the large NPAs were in the form of loans to non-operating entities, while
only 4% were in the form of loans to projects under implementation.
More power to banks, tougher life for corporates
By Times of India (Dated June 15, 2004)
The Finance ministry is readying amendments to the Securitisation Act

which

deals with corporate defaulters owing over Rs.100,000 crores to Banks

and Fls
I
in gross bad debt. The Government wouldn't be seen a being soft on
corporate
defaulters at a time when a large number of farmers are reeling under the
debt burden and are often having to pay back literally through their lives.
The amendments will be drafted in the light of the recent judgment of the
Supreme Court in the Mardia Chemicals case. The Government would
not take any chances about cases of coporate default dragging on in
litigations. The amendments are expected to further strengthen the hands
of the banks to quickly dispose off assets they have taken over for
recovering their dues. The Government is assured that the Supreme Court
judgment in the Mardia Chemicals case is basically sound as the it upheld
the Securitisation Act which allows the lender to serve a 60-day notice on
the defaulter for repayment, In case the borrower company fails to pay
up, the bank is allowed under the Act to take over the assets and even the
company.
The court however struck down the clause in the Act that allowed the
defaulter company to seek legal redress against the lender disposing off
the assets only after it made a payment of 75% of the claimed amount. In
the Mardia case the Supreme Court allowed the defaulter company to go
to the Debt Recovery Tribunal for red ressa I without the need of making
the 75% payment. This was however viewed by the banking community
as a threat to the powers that have been bestowed upon them by the Act.

Punjab National Bank takes up Securitisation Act to recover

Rs.114cr
bad loans
Economic Times dated 2nd August, 2004
With a penchant to lower its Non Performing Assets PNB North Zone has
adopted tough postures to make defaulting borrowers see reason. Armed
with the Securitisation Act the bank has thus, issued 731 notices to
defaulting borrowers comprising a network of branches in Haryana,
Jammu & Kashmir and Chandigarh involving an amount of Rs.113.6
crores.
The bank's manager said that notices served to the defaulting managers
had made as many as 326 borrowers to approach the bank for
compromises amounting to Rs.44.6 Cr while in case of 315 defaulters
compromise proposals had been settled involving an amount of Rs.37.8Cr
Moreover, 254 accounts with a balance of Rs.14.2 Cr have since been

adjusted and 42 accounts with a balance of Rs.2.6Cr have been upgraded
from the NPA category and the bank in the process recovered Rs.25.9 Cr
in 516 accounts.
The bank has also taken into its possession one electronic equipment
manufacturing unit in Mohali owning over Rs.3crores. This unit would
now be auctioned and the sale for the auction had been fixed for this
month.
Indian Banks on strong footing

By Times of India
The NPA figures for Indian banks were very high hovering around 20%
in the 1980's and the problem of high staffing and inefficiency plagued
the banking sector. However stringent norms imposed over the years, for
defaulters, debt recovery and for NPAs as well as the overall banking
reform have brought down the NPA percentage over the years. The
reforms also strengthened the banking systems credit ratings and pulled
several banks away from the possible insolvency. In the financial year
2000, faced by a recession in the Indian manufacturing sector, NPAs had
once again climbed to close to 15 % of gross advances, but since then has
come down substantially. In the last few years the strengthening of the
banks for recovery of bad debts through the Securitisation Act have
dramatically changed the workings of the Indian banking sector itself.
This is likely to cycle out and further improve the overall functioning of
the sector NPAs in Indian banks fell from 14% as a percentage of total
advances in financial year 2000 to 8.8% in financial year 2003.
CONCLUSION
The literature review has been very useful and informative as it has
thrown light on the research and articles that have been written on the
growing problems of Non Performing Assets in the banking sector, its
adverse effects on the functioning of the banks and the various
mechanisms available for recovery of the NPAs with special reference to
the recently enacted Securitization Act.
Moreover it has helped in identifying the degree of research that
has already been done on the subject. It has narrowed the scope of
repetition and has formed the basis of secondary data for this study.

Benefits derived from the Review of Literature:

Helps to identify the problem statement

Helps to focus on the specific line of research

Helps a layman understand what is a non_performing asset and the
role of the Securitisation Act in the reduction of NPAs

Recognizes the key issues in the implementation of the
Securitisation Act

Literature review gives us an insight on the objectives of the Act
and the impact it has generated in the reduction of NPAs in the
banking sector

Throws light on the areas where the Act is rendered ineffective

Helps in the identification of the loopholes in the securitization act
and facilitates to make recommendations for plugging the same.
Methodology
Research method:
The nature of research was exploratory as well as diagnostic
as the study was aimed at exploring the impact of securitization Act on
the NPAs in the banking sector. This study is based on the discussions
conducted with officials of the bank. The various data provided by

them, the RBI circulars, journals, magazines, data from internet were
thoroughly studied and interpretations made thereof.
Research design:
Research design is a statement or specification of procedures
for collecting and analyzing the information required for the solution
of specific problem. It provides a specific framework for conducting
some research investigation.
Sources of data:
Primary sources:
Primary data was collected from officials through
discussions.
Secondary data:
It was collected from annual reports, management reports,
magazines, RBI circulars, sources from internet were studied.
Sampling unit:
The sampling unit was banks especially the loan managers,
the credit managers and the officers’ incharge of recovery department.
The banks were chosen randomly.
Sample size:
The total sample size was five banks.
STATISTICAL ANALYSIS USING T-TEST.
Hypothesis:
Ho: The securitization Act is not successful in the reduction of
NPAs in the banking sector.
H1: The securitization Act is successful in the reduction of NPAs
in the banking sector.

BANKS ELIGIBLE A/CS RECOVERED A/CS

No. of Amt in No. of Amt in
A/Cs crores A/Cs crores
1 97 559 73 403
2 285 46.57 193 10.42
3 208 76.81 65 11.64
4 159 1589 43 164
5 155 593.26 129 370.41
PARTICULARS d d2
(0559.00) - (0403.00) 156 24336
(0046.57) - (0010.42) 36.15 1306.8225
(0076.81) - (0011.64) 65.17 4247.1289
(1589.00) - (0164.00) 1425 2030625
(0593.26) - (0370.41) 222.85 49662.1225
TOTAL 1905.17 2110177.074

Sd = 576.164
T cal = 6.6133
T tab = 2.132
If T cal > T tab Ho is rejected, in otherwords H1 is accepted
6.6133 > 2.132
With the above calculation it is proved that the SARFAESI Act is

effective to reduce the NPAs in banking sector.

ANALYSIS AND INTERPRETATION
Reasons for NPAs in the Bank
Table 1: showing the reason for NPAs in the bank
REASONS PERCENTAGE (%)

Diversion of funds 58
Absence of security 12
Lack of effective follow up 36
Management failures 18
Difficulty in execution of decrees 36
Willful default 48
Improper credit appraisal 52
Demand recession 12
Decrepit legal system 42
Cost ineffective legal measure 36
Others 0
Chart showing reasons for NPAs (%)
Interpretation:
From the table it is clear that the main reason for NPAs in banks is
diversion of funds, improper credit appraisal and willful default followed

by cost ineffective legal measures and difficulty in the execution of

decrees.
Measures for the recovery of NPAs
Table 2
PREFERENCES PERCENTAGE (%)

Legal 18
Non legal 6
Both legal & non legal 76
others 0
Graph showing the measures undertaken by the bank for recovery of

NPAs
o the rs L e ga l
0% 18%
N o n le ga l
6%
B o th le ga l &
no n le ga l
76%

Interpretation:
From the graph it can be interpreted that 76% of the respondents

said that they take both legal & non legal measures for the recovery of
NPAs, while 18% said they take only legal measures and 6% said they
take only non-legal measures for the recovery of NPAs.
Recovery mechanisms adopted by the bank for NPAs pre

Securitization Act.
Table 3
RECOVERY MECHANISMS PERCENTAGE (%)

Lok Adalat 18
Civil courts 52
Debt Recovery Tribunal’s 52
One time settlement scheme 58
Others 0
Graph showing the recovery mechanism adopted by the bank pre

securitization Act

60 58
52 52
50
40
30
20 18
10
0
0
Lok Adalat Civil courts Debt One time Others
Recovery settlement
Tribunal’s scheme
Interpretation:
58% of the respondents said they adopted one time settlement

scheme for the recovery of NPAs as pre-securitization Act, while 52% of
the respondents said they adopted both civil courts and debt recovery
tribunals’ mechanisms and 18% said they adopted Lok Adalats .
Recovery mechanisms adopted post-securitization Act.
Table 4
RECOVERY MECHANISMS PERCENTAGE (%)

Lok Adalats 12
Civil courts 30
Corporate debt restructuring 18
Debt recovery tribunals 52


ARC’s/securitization companies 42
Others 0
Graph showing the recovery mechanisms adopted by the bank post-

securitization Act.
60 58
52
50
42
40
30 30
20 18
12
10
0
0
Lok Civil CDR DRT OTS ARC’s/ Others
Adalats courts SEC CO's
Interpretation:
58% are said to adopt one time settlement scheme as a recovery

mechanism for NPAs post securitization Act,52% said debt recovery
tribunals,42% said asset reconstruction companies,30% said civil
courts,18% said corporate debt reconstruction and 12% said Lok Adalats.
Measures for effective recovery of NPAs
Table 5
Preference Percentage (%)

Lok Adalats 12

Debt Recovery Tribunals 12

Civil courts 0
Corporate debt restructuring 6
Asset reconstruction/securitization companies 12
Others 0
Graph showing the effective measures of recovery
P ercentage (% )
Others
ARC's 0%
12%
CDR
6%
Civil courts
0%
OTS
DRT 58%
12%
Lok Adalats
12%
Interpretation:
58% of them said that One Time Settlement Scheme is the most
effective recovery mechanism, while 12% said Lok Adalats, 12% said
Asset Reconstruction Companies, 12% said Debt Recovery Tribunals and
6% said Corporate Debt Restructuring.
Has securitization Act empowered the Banks with additional powers

by facilitating the formation of Assets Reconstruction/Securitization
companies?
Table 6

PREFERENCE PERCENTAGE (%)

Yes 100
No 0
Graph showing whether the securitization Act empowered the Banks with
additional powers or not.
PERCENTAGE (%)
100
80
60
40
20
0
Yes No
Interpretation:
100% said that the securitization Act has empowered the Banks
with additional powers by facilitating the setting up of Asset
Reconstruction companies/Securitization companies.
Has the enactment of securitization Act reduced the level of NPAs in

the Banks?
Table 7
PREFERENCE PERCENTAGE (%)

Yes 88
No 0
Cant’ say 12

Graph showing whether the Act reduced the level of the NPAs in the
Banks.
Interpretation:
88% of them said that the enactment of the securitization Act has
reduced the leval of NPAs in the Banks, while 12% said they can’t say
whether the Act helped in the reduction of NPAs in the Banks.
Rating of the impact of the securitization Act in the reduction of

NPAs on a scale of 1 to 10.
Table 8
RATING PERCENTAGE (%)

Below 5 12
5 & above 88
Graph showing the rate of impact of the Act in the reduction of NPAs
Interpretation:
88% of the respondents rated 5 and above is the impact of the

securitization Act in the reduction of NPAs and 12% rated below 5. From
this it can be interpreted that the Act has been successful in the reduction
of NPAs in the banking sector.
Issues of concern for the banks in the implementation of the Act for
the recovery for NPAs
• Disposal of securities is difficult without court intervention

• Lack of market for such securitized assets

• Non-commencement of asset reconstruction and securitization
companies
• Difficulty in seizing the said property with tenants and
leaseholders occupying the property
• Under the Act, the Bank has to issue a notice and wait for 60 days
before proceedings to take procession of the security and during
this period the borrowers are degrading the quality of the assets
and are rendering them less value.
• Stays from civil courts by the parties against the action initiated by
the banks for seizure.
• Cost of maintenance to the bank of the seized assets
• Parties delaying the process by contending in courts/DRTs
• Inability to prevent alienation of the said property by the
borrowers during the notice period
• Threats from the borrowers to the Bankers.
ANALYSIS OF INDIVIDUAL BANKS UNDER STUDY
Table showing the Gross NPAs in priority sector as well as non-

priority sector lending of
Bank 1.

Gross NPAs Gross NPAs

Priority sector Non priority sector
Financial year Amount in As a % of Amount in As a % of
crores advances crores advances
2001 572 30 221 10
2002 501 35 238 12
2003 412 36 242 13
2004 344 38 219 9
2005 240 15 112 4
Total 2069 154 1032 48
GRAPH:
700
600
500 Priority sector
400
300 Non Priority
200 Sector
100
0
2001 2002 2003 2004 2005
Table showing the total recovery
Period 2002-2005 No of A/Cs Amt Rs. Crores

A/Cs eligible for Act 97 559
Notice served A/Cs 97 559
Recovery by notice 69 388

Recovery by sale 4 15
TOTAL Recovery 73 403
Graph :
600
500
400
300
No of A/Cs
200
Amt Rs. Crores
100
0
A/Cs Recovery TOTAL
eligible for by notice Recovery
Act
Interpretation:
97 Alcs were eligible for recovery under the act, notices were
issued under the act for 97 Alcs an the total recovered Ales were 73 out
of which 69 Ales were
recovered through notice and 4 by sale.
Percentage of recovery:
73 /97 *'100 = 75%.

Hence it can be interpreted that the act has been successful in the
reduction of NPAs in the bank.

Bank 2.

2002 25.43 4.98 34.79 3.4

2003 111.91 17.9 40.85 3.71
2004 201.16 21.76 71.43 9.63
2005 86.51 8.02 40.78 4.84
Total 425.01 52.66 87.85 21.58
GRAPH:
250
200
150 Priority Sector

100 Non Priority Sector
50
0
2002 2003 2004 2005


A/Cs eligible for Act 285 46.57
Notice served A/Cs 246 27.87
Recovery by notice 193 10.42
TOTAL Recovery 193 10.42
Graph :
300
250
200
150
No of A/Cs
100
Amt Rs. Crores
50
0
A/Cs Recovery
eligible by notice
for Act
Interpretation: While 285 A/cs of NPAs were eligible to be recovered

under the act only on 246 A/cs notices under the act were served and the
total recovery is of 193 A/cs.
Percentage of recovery is obtained by dividing the total recovery Ales

by the notice served Ales which is 193 I 246 *100 = 78%.


Bank 3.

2001 325.8 10.09 317.74 9.85
2002 306.22 8.78 282.5 8.1
2003 307.27 7.64 277.73 6.9
2004 305.57 5.64 291.8 5.39
2005 328.87 10.1 510.34 15.68
Total 1573.73 42.25 1680.11 45.92
GRAPH:
600
500
400
300 Priority Sector
200 Non Priority
100
0
2001 2002 2003 2004 2005


Graph :
250
200
150 No of A/Cs
100 Amt Rs. Crores
50
0
le
e
Cs
ct
t ic
sa
rA
A/
no
by
fo
ed
y
le
ry
rv
ib
ve
ry
se
ig
ve
co
el
co
tic
Re
s
C
Re
No
A/
Interpretation: While 208 A/cs of NPAs were eligible to be recovered

under the act only on 160 A/cs notices were served under the act and the
total recovered accounts were 65.
Total recovery A/cs divided by the notice served Ales that is
65/160 *100 = 41% (rounded off)
Hence it can be interpreted that the Act has not been so successful in the

Bank 4.

2001
2002 13.76 7 3.44 1.75
2003 13.17 4.76 3.29 1.19
2004 14.24 3.21 3.56 0.8
2005 14.88 2.32 3.72 0.58
Total 56.05 17.29 14.01 4.32
GRAPH:
20
15 Priority Sector
10
Non Priority
5 Sector
0
2001 2002 2003 2004 2005


A/Cs eligible for Act 159 1589
Notice served A/Cs 79 741
Recovery by notice 43 164
TOTAL Recovery 43 164
Graph :
2000
1500
No of A/Cs
1000
Amt Rs. Crores
500
0
Recovery
Recovery
by notice
eligible
TOTAL
A/Cs
Interpretation: While 159 A/cs were eligible under the Act for recovery
notices were served on
79 A/cs and the total recovered A/cs were 43.
43/79 *100 = 54%

Bank 5.


2001 604.08 7 469.84 9
2002 655.56 9 364.20 5
2003 593.12 8 667.26 9
2004 5.8.69 6.5 626.08 8
2005 440.69 5.5 520.78 6.5
Total 2802.14 36 2648.16 37.5
GRAPH:
800
600 Priority Sector

400
Non Priority
200 Sector
0
2001 2002 2003 2004 2005



Recovery by sale 14 88.74
Graph:
600
500
400
300
200 No of A/Cs
100 Amt Rs. Crores
0
A/Cs Recovery
eligible by notice
for Act
Interpretation:
155 Ales were eligible for recovery under the act and notices were
served under
the act for 145 alcs and the total recovered alcs were 129 out of which
115 were
recovered by notice and 14 through sale.
129 /145 * 100 = 89% (rounded off).

Hence it can be interpreted that the Act has been successful in the
Total recovery of all five banks
Table 14 showing the total recovery of all the five banks

Period 2002-2005 No of Ales

Notice served A/Cs 727
Recovery by notice 485
recovery by sale 18
TOTAL Recovery 503
Graph:
TOTAL
Recovery Notice
41% served
A/Cs
59%
Interpretation:
As the percentage of recovery is seventy percent, it can be interpreted that
the Act has been successful in the reduction of NPAs in the banking
sector.
Total recovery Ales divided by the notice served A/cs that is
503 I 727* 100 = 70% (rounded off)

FINDINGS
¾
An asset is treated as a Non Performing Asset, if interest and/or
installment of principal remains overdue for a period exceeding 90
days (w.eJ.1st April 2004)
¾
The main reasons for an account becoming a non- performing asset
are diversion of funds, improper credit appraisal and willful default
followed by cost ineffective legal measures and difficulty in the
execution of decrees.
¾
Before the enactment of the Securitization Act the banker had
limited options for recovery which consisted of having an intensive
follow-up and interaction with the borrower and initiating legal
actions either through courts or Debt recovery tribunals.
¾
The Securitisation Act empowers Banks/Fls to change or takeover
the management/possession of secured assets of the defaulting
borrowers& sell or lease out the assets without the intervention of
the court.
¾
The measures to tackle the NPAs adopted by the bank post
Securitization Act include:
o Issuing notices as per the SRFAESI Act and waiting for 60

days
o Issue possession notice after 60 days and initiate steps to
take physical possession of securities
o Sell the securities and adjust the amount to the NPAs.
¾The Act is applicable only if claim in respect of the financial asset

is made
Within the period of limitation prescribed under the Limitation
Act, 1963(36)
¾
The Securitization Act is not applicable in case of agricultural
properties
¾The act is not applicable to any security interest for securing
repayment of any financial asset not exceeding one lakh rupees.
¾The major issues of concern with the implementation of the Act
are:
o Inability to dispose off the assets acquired under the act by
the banks due to lack of market for such assets.
o Problems in disposing of land due to the restrictions imposed
by the land ceiling laws.
o Pricing of the acquired assets by the bank in the process of
selling them to Asset reconstruction companies which
involves huge discounts
o The provisions of the act are applicable only in the case of
doubtful and loss assets
o Parties delaying the proceedings initiated by the banks under
the act by contending in the courts/DRTs.
o Difficulty in seizing the said property with tenants and
leaseholders occupying the property
o Stays from civil courts by the parties against the action
initiated by the banks for seizure
o Another issue of concern is the quality of the securitized
asset.
¾
As per the Securitization Act the role of the Court was limited to
challenge the measures under Section 13(4), by way of Appeal, that

too on deposit of 75% of amount claimed on the notice under

Section 13(2) of the Act.
¾
Although the Securitisation Act empowers banks/Fls to seize the
secured assets of the defaulting borrowers without the intervention
of the courts, borrowers are still able to get the proceedings under
the act stayed by appealing in civil courts and DRTs.
¾
Despite the many issues of concerns in the implementation of the
act overall the Act has been a boon for the banking community.
¾
Majority of the bankers opined that the act was helpful in the
reduction of NPAs.
¾
However, recently the Supreme Court in the case of Mardia
chemicals has struck down the clause in the act that allows the
borrower to seek legal redress only upon paying 75% of the
claimed amount to the lending bank as unconstitutional.
¾
This Supreme Court decision is viewed as a threat to the effective
implementation of the act by the banking community as it enables
borrowers to make appeals on flimsy grounds without depositing
any amount with the lender bank.

CONCLUSION
The Securitization Act is a fine, comprehensive piece of

legislation; it is also a reassuring sign of Government's commitment to
reforms. The Act empowers the banks to change or take over the
management or even take possession of secured assets of the borrowers
and sell or lease out the assets. This is the first time that the banks can
takeover the immovable assets of the defaulting borrowers without the
intervention of the courts. Banks under the act can claim future
receivables and supercede the Board of Directors of the defaulting
corporates. No court, other than the Debt Recovery Tribunal can entertain
an appeal against the action taken by the banks under this Act.
Since the enactment of the Securitization Act, it was seen as a

panacea to the entire problem of NPAs. The banks are euphoric about the
act and are taking actions swiftly by issuing notices to the defaulting
borrowers. Defaulting borrowers who were not responding previously
started responding favorably and cash recoveries became a reality.
However nothing spectacular has happened, there are not many cases
where change of management has been affected or taking over the entire
assets of a large manufacturing unit etc. This is due to the various
intricacies involved in the implementation of the act and its consequences
like interference of courts/DRTs in the proceedings initiated by the banks
under the act by way of granting stay orders, lack of market for such
securitized assets, lack of managerial expertise in case of such assets,
concerns of holding costs of such assets to the banks, the recent Supreme
court decision with regard to the striking down of the upfront payment by
the borrower before appeal warranted by the act as unconstitutional and
the like.

In view of the above mentioned concerns it can be concluded, after

the analysis that overall the act has empowered the banks with additional
powers for recovery and facilitated the reduction of NPAs to the extent of
70%, however much needs to be done by way of recovery reforms and
development of market for distressed assets for the Act to be more
effective in realizing its proposed objectives.

SUGGESTIONS
The following are the suggestions to make the Securitisation Act more
meaningful and effective.
¾
In India, bulk of the NPAs relate to units that are either defunct or
in sectors like steel and textiles that have become uncompetitive or
obsolete with the opening up of the economy, lowering of tariffs or
introduction of modern technology etc. Unlike other countries,
where there are specialized markets for buying out the NPAs and
selling them overtime, there is no market for distressed assets in
India. Hence specialized markets for such securitized assets must
be established.
¾
Private investors should also be allowed to invest in securitized
NPAs.
¾
Asset reconstruction companies resort to issuance of bonds against
assets transferred from the banks. There should be a mechanism
whereby such bonds are guaranteed.
¾
Banks and Asset reconstruction companies must be given sufficient
legal powers to recover the assets and dispose them off without the
intervention of the courts.
¾
The banks and Fls will be shareholders as well as the customers of
the ARCs and hence they have an interest in its financial
performance, therefore the ARCs have to be given operational
independence.
¾
Banks should recognize hidden losses in transfer of NPAs to
ARCs, if banks transfer the NPAs at the market price they will
have to book further losses. Government should evolve a
mechanism to quantify these losses and arrange to recapitalise

banks.
¾
The NPA assets must be rated by a rating agency which would
facilitate the market for such assets, this would in turn reduce the
holding cost of the seized assets to the bank.
¾
Recognition of the sale of property by the banks under the
Securitisation
act by the Registrar.
¾
The act has to be made applicable to agricultural properties also,
this
would help curb the level of. NPAs in the priority sector lending by
the
banks.
¾
The upfront payment by the borrower for challenging the action of
the
bank under the act should be re-introduced with a lesser percentage of
the
claimed amount.
¾
The lending bank should be given more powers to seize and
dispose off the security and to attach any other additional
security/asset available with the defaulting borrower and court
intervention in such proceeding should be eliminated.
¾
The Act has to be made applicable for recovery of all dues of banks
and Fls irrespective of the Limitations Act.
¾
The Act has to be given same weightage on par with Revenue
Recovery
Act.
¾
The escape routes for defaulters like the interference of the Debt
Recovery Tribunal etc are to be removed.
¾
Bankers handling the recovery operations should be educated on

the management and disposal process of the acquired assets and

should also be provided with management expertise while taking
over the operations of the companies.
¾
The powers currently available to the bankers under the Act should
be explained to both the borrowers and the bankers for the effective
implementation of the Act.

SrividyaV 0352 NonPerformingAssets

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Non Performing Assets

A STUDY OF THE MANAGEMENT

Under the guidance of

M.P. BIRLA INSTITUTE OF MANAGEMENT

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 1

This to certify that the dissertation titled “A study on management of NPAs

Place: Bangalore (Dr. Nagesh S Malavalli)

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 2

This to certify that the dissertation titled “A study on management of

Place: Bangalore (Prof.B.K. Ramaswamy)

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 3

I declare that this dissertation titled “A study on management of

Place: Bangalore (Srividya V)

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 4

This dissertation is the study of the management of non-

The purpose of the dissertation is to study the various provisions

The research is done in respect to five banks chosen randomly ,by

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 5

intervention of the court. The major issues of concern with the

The statistical test is done using T- test where it was statistical

The recommendations are that the banks and asset

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 6

2. Review of Literature 89-94

3. Research methodology 95-97

4. Data Analysis and Interpretation 98-117

5. List of findings 118-120

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 7

Table Contents Page No.

Table 1 Gross and Net NPA of Scheduled Commercial 3

Table 4 Liability profile of Banks 13

Table 5 Asset profile of banks 14

Table 6 Net NPA (as a percentage of Net Advances) 23

Table 7 Revised guidelines 53

Table 8 Regulatory framework 57

Table 9 Secured portion 71

Table 10 Statistical analysis 96

Table 11 The reason for NPAs in the bank 98

Table 12 Measures for the recovery of NPAs 99

Recovery mechanisms adopted by the bank for 100

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 8

Measures for effective recovery of NPAs 102

Empowerment of addl. power 103

Table 18 Impact of securitization 104

Table 19 Bank 1 107

Table 20 Bank 2 109

Table 21 Bank 3 111

Table 22 Bank 4 113

Table 23 Bank 5 115

Table 24 Total recovery 117

M.P BIRLA INSTITUTE OF MANAGEMENT ASSOCIATATE BHATATIYA VIDYA BHAVAN 9

Chart 2 Reasons for NPAs 98

Chart 3 Measures for the recovery of NPAs 99

Chart 4 Recovery mechanisms adopted by the bank for NPAs 100

Chart 5 Recovery mechanisms adopted post-securitization 101

Chart 7 Empowerment of addl. power 103

Chart 8 Have NPAs reduced 104

Chart 9 Impact of securitization 105

Chart 10 Bank 1 107

Chart 11 Bank 2 109

Chart 12 Bank 3 111

Chart 13 Bank 4 113

Chart 14 Bank 5 115