EXECUTIVE SUMMARY

The future of Indian Banking represents a unique mixture of unlimited opportunities amidst insurmountable challenges. On the one hand we see the scenario represented by the rapid process of globalization presently taking shape bringing the community of nations in the world together, transcending geographical boundaries, in the sphere of trade and commerce, and even employment opportunities of individuals. All these indicate newly emerging opportunities for Indian Banking. But on the darker side we see the accumulated morass, brought out by three decades of controlled and regimented management of the banks in the past. It has siphoned profitability of the Government owned banks, accumulated bloated NPA and threatens Capital Adequacy of the Banks and their continued stability. Nationalized banks are heavily over-staffed. The recruitment, training, placement and promotion policies of the banks leave much to be desired. In the nutshell the problem is how to shed the legacies of the past and adapt to the demands of the new age. PSBs in India can solve their problems only if they assert a spirit of self-initiative and self-reliance through developing their in-house expertise. They have to imbibe the banking philosophy inherent in de-regulation NPA is a problem created by the Banks and they have to find the cause and the solution - how it was created and how the Banks are to overcome it. An attempt is made in this study the present situation and to arrive at a solution to solve this problem.

INTRODUCTION 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 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. MEANING OF NPAs: An asset is classified as non-performing asset (NPAs) if dues in the form of principal and interest are not paid by the borrower for a period of 180 days. However with effect from March 2004, default status would be given to a borrower if dues are not paid for 90 days. If any advance or credit facilities granted by bank to a borrower becomes non-performing, then the bank will have to treat all the advances/credit facilities granted to that borrower as non-performing without having any regard to the fact that there may still exist certain advances / credit facility. NPA IN INDIAN BANKING SYSTEM: NPA surfaced suddenly in the Indian banking scenario, around the Eighties, in the midst of turbulent structural changes overtaking the international banking institutions, and when the global financial markets were undergoing sweeping changes. In fact after it had emerged the problem of NPA kept hidden and gradually swelling unnoticed and unperceived, in

the maze of defective accounting standards that still continued with Indian Banks up to the Nineties and opaque Balance sheets. In a dynamic world, it is true that new ideas and new concepts that emerge through such changes caused by social evolution bring beneficial effects, but only after levying a heavy initial toll. The process of quickly integrating new innovations in the existing set-up leads to an immediate disorder and unsettled conditions. People are not accustomed to the new models. These new formations take time to configure, and work smoothly. The old is cast away and the new is found difficult to adjust. Marginal and sub-marginal operators are swept away by these convulsions. Banks being sensitive institutions entrenched deeply in traditional beliefs and conventions were unable to adjust themselves to the changes. They suffered easy victims to this upheaval in the initial phase. Consequently banks underwent this transition-syndrome and

languished under distress and banking crises surfaced in quick succession one following the other in many countries. But when the banking industry in the global sphere came out of this metamorphosis to re-adjust to the new order, they emerged revitalized and as more vibrant and robust units. Deregulation in developed capitalist countries particularly in Europe, witnessed a remarkable innovative growth in the banking industry, whether measured in terms of deposit growth, credit growth, growth intermediation instruments as well as in network. During all these years the Indian Banking, whose environment was insulated from the global context and was denominated by State controls of directed credit delivery, regulated interest rates, and investment structure did
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not participate in this vibrant banking revolution. Suffering the dearth of innovative spirit and choking under undue regimentation, Indian banking was lacking objective and prudential systems of business leading from early stagnation to eventual degeneration and reduced or negative profitability. Continued political interference, the absence of competition and total lack of scientific decision-making, led to consequences just the opposite of what was happening in the western countries. Imperfect accounting standards and opaque balance sheets served as tools for hiding the shortcomings and failing to reveal the progressive deterioration and structural weakness of the country's banking institutions to public view. This enabled the nationalized banks to continue to flourish in a deceptive manifestation and false glitter, though stray symptoms of the brewing ailment were discernable here and there. The government hastily introduced the first phase of reforms in the financial and banking sectors after the economic crisis of 1991. This was an effort to quickly resurrect the health of the banking system and bridge the gap between Indian and global banking development. Indian Banking, in particular PSBs suddenly woke up to the realities of the situation and to face the burden of the surfeit of their woes. Simultaneously major revolutionary transitions were taking place in other sectors of the economy on account the ongoing economic reforms intended towards freeing the Indian economy from government controls and linking it to market driven forces for a quick integration with the global economy. Import restrictions were gradually freed. Tariffs were brought down and quantitative controls were removed. The Indian market was opened for free competition to the global players. The new economic policy in turn revolutionalised the environment of the

Indian industry and business and put them to similar problems of new mixture of opportunities and challenges. As a result we witness today a scenario of banking, trade and industry in India, all undergoing the convulsions of total reformation battling to kick off the decadence of the past and to gain a new strength and vigor for effective links with the global economy. Many are still languishing unable to get released from the old setup, while a few progressive corporates are making a niche for themselves in the global context. During this decade the reforms have covered almost every segment of the financial sector. In particular, it is the banking sector, which experienced major reforms. The reforms have taken the Indian banking sector far away from the days of nationalization. Increase in the number of banks due to the entry of new private and foreign banks; increase in the transparency of the banks' balance sheets through the introduction of prudential norms and norms of disclosure; increase in the role of the market forces due to the deregulated interest rates, together with rapid computerization and application of the benefits of information technology to banking operations have all significantly affected the operational environment of the Indian banking sector. In the background of these complex changes when the problem of NPA was belatedly recognized for the first time at its peak velocity during 1992-93, there was resultant chaos and confusion. As the problem in large magnitude erupted suddenly banks were unable to analyze and make a realistic or complete assessment of the surmounting situation. It was not realized that the root of the problem of NPA was centered elsewhere in multiple layers, as much outside the banking system, more particularly in the
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transient economy of the country, as within. Banking is not a compartmentalized and isolated sector delinked from the rest of the economy. As has happened elsewhere in the world, a distressed national economy shifts a part of its negative results to the banking industry. In short, banks are made ultimately to finance the losses incurred by constituent industries and businesses. The unprepared ness and structural weakness of our banking system to act to the emerging scenario and de-risk itself to the challenges thrown by the new order, trying to switch over to globalization were only aggravating the crisis. Partial perceptions and hasty judgments led to a policy of ad-hoc-ism, which characterized the approach of the authorities during the last two-decades towards finding solutions to banking ailments and dismantling recovery impediments. Continuous concern was expressed. Repeated correctional efforts were executed, but positive results were evading. The problem was defying a solution. The threat of NPA was being surveyed and summarized by RBI and Government of India from a remote perception looking at a bird's-eye-view on the banking industry as a whole delinked from the rest of the economy. RBI looks at the banking industry's average on a macro basis, consolidating and tabulating the data submitted by different institutions. It has collected extensive statistics about NPA in different financial sectors like commercial banks, financial institutions, urban cooperatives, NBFC etc. But still it is a distant view of one outside the system and not the felt view of a suffering participant. Individual banks inherit different cultures and they finance diverse sectors of the economy that do not possess identical attributes. There are distinct diversities as among the 29 public sector banks themselves, between different geographical regions and between different types of

customers using bank credit. There are three weak nationalized banks that have been identified. But there are also correspondingly two better performing banks like Corporation and OBC. There are also banks that have successfully contained NPA and brought it to single digit like Syndicate (Gross NPA 7.87%) and Andhra (Gross NPA 6.13%). The scenario is not so simple to be generalized for the industry as a whole to prescribe a readymade package of a common solution for all banks and for all times. Similarly NPA concerns of individual Banks summarized as a whole and expressed as an average for the entire bank cannot convey a dependable picture. It is being statistically stated that bank X or Y has 12% gross NPA. But if we look down further within that Bank there are a few pockets possessing bulk segments of NPA ranging 50% to 70% gross , which should consequently convey that there should also be several other segments with 3 to 5% or even NIL % NPA, averaging the bank's whole performance to 12%. Much criticism is made about the obligation of Nationalized Banks to extend priority sector advances. But banks have neither fared better in non-priority sector. The comparative performance under priority and non-priority is only a difference of degree and not that of kind. The assessment of the mix-of contributing factors includes: 1. human factors (those pertaining to the bankers and the credit customers), 2. environmental imbalances in the economy on account of wholesale changes and also 3. Inherited problems of Indian banking and industry.

Variable skill, efficiency and level integrity prevailing in different branches and in different banks accounts for the sweeping disparities between interbank and intra-bank performance. We may add that while the core or baselevel NPA in the industry is due to common contributory causes, the inter-se variations are on account of the structural and operational disparities. The heavy concentrated prevalence of NPA is definitely due to human factors contributing to the same. No bank appears to have conducted studies involving a cross-section of its operating field staff, including the audit and inspection functionaries for a candid and comprehensive introspection based on a survey of the variables of NPA burden under different categories of sectoral credit, different regions and in individual Branches categorized as with high, medium and low incidence of NPA. We do not hear the voice of the operating personnel in these banks candidly expressed and explaining their failures. Ex-bankers, i.e. the professional bankers who have retired from service, but possess a depth of inside knowledge do not out-pour candidly their views. After three decades of nationalized banking, we must have some hundreds of retired Bank executives in the country, who can boldly and independently, but objectively voice their views. Everyone is satisfied in blaming the others. Bank executives hold 'willful defaulters' responsible for all the plague. Industry and business blames the government policies. An important fact-revealing information for each NPA account is the gap period between the date, when the advance was originally made and the date of its becoming NPA. If the gap is long, it is the case of a sunset industry. Things were all right earlier, but economic variance in trade cycles or market sentiments have created the NPA. Credit customers who are in
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NPA today, but for years were earlier rated as good performers and creditworthy clients ranging within the top 50 or 100. Significant part of the NPA is on account of clout banking or willfully given bad loans. Infant mortality in credit is solely on account of human factors and absence of human integrity. Credit to different sectors given by the PSBs in fact represents different products. Advance to weaker sections below Rs.25000/- represents the actual social banking. NPA in this sector forms 8 TO 10% of the gross amount. Advance to agriculture, SSI and big industries each calls for different strategies in terms of credit assessment, credit delivery, project implementation, and post advance supervision. NPA in different sector is not caused by the same resultant factors. Containing quantum of NPA is therefore to be programmed by a sector-wise strategy involving a role of the actively engaged participants who can tell where the boot pinches in each case. Business and industry has equal responsibility to accept accountability for containment of NPA. Many of the present defaulters were once trusted and valued customers of the banks. Why have they become unreliable now, or have they? The credit portfolio of a nationalized bank also includes a number of low-risk and risk-free segments, which cannot create NPA. Small personal loans against banks' own deposits and other tangible and easily marketable securities pledged to the bank and held in its custody are of this category. Such small loans are universally given in almost all the branches and hence the aggregate constitutes a significant figure. Then there is food credit given to FCI for food procurement and similar credits given to major public Utilities and Public Sector Undertakings of the Central Government. It is
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only the residual fragments of Bank credit that are exposed to credit failures and reasons for NPA can be ascertained by scrutinizing this segment. Secondly NPA is not a dilemma facing exclusively the Bankers. It is in fact an all pervasive national scourge swaying the entire Indian economy. NPA is a sore throat of the Indian economy as a whole. The banks are only the ultimate victims, where life cycle of the virus is terminated. Now, how does the Government suffer? What about the recurring loss of revenue by way of taxes, excise to the government on account of closure of several lakhs of erstwhile vibrant industrial units and inefficient usage of costly industrial infrastructure erected with considerable investment by the nation? As per statistics collected three years back there are over two and half million small industrial units representing over 90 percent of the total number of industrial units. A majority of the industrial work force finds employment here and the sector's contribution to industrial output is substantial and is estimated at over 35 percent while its share of exports is also valued to be around 40 percent. Out of the 2.5 million, about 10% of the small industries are reported to be sick involving a bank credit outstanding around Rs.5000 to 6000 Crores, at that period. It may be even more now. These closed units represent some thousands of displaced workers previously enjoying gainful employment. Each closed unit whether large, medium or small occupies costly developed industrial land. Several items of machinery form security for the NPA accounts should either be lying idle or junking out. In other words, large value of land, machinery and money are locked up in industrial sickness. These are the assets created that have turned unproductive and these represent the real physical NPA, which indirectly are reflected in the financial statements of nationalized banks, as the ultimate
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financiers of these assets. In the final analysis it represents instability in industry. NPA represents the owes of the credit recipients, in turn transferred and parked with the banks. Recognizing NPA as a sore throat of the Indian economy, the field level participants should first address themselves to find the solution. Why not representatives of industries and commerce and that of the Indian Banks' Association come together and candidly analyze and find an everlasting solution heralding the real spirit of deregulation and decentralization of management in banking sector, and accepting self-discipline and selfreliance? What are the deficiencies in credit delivery that leads to its misuse, abuse or loss? How to check misuse and abuse at source? How to deal with erring Corporates? In short, the functional staff of the Bank along with the representatives of business and industry have to accept a candid introspection and arrive at a code of discipline in any final solution. And preventive action to be successful should start from the credit-recipient level and then extend to the bankers. RBI and Government of India can positively facilitate the process by providing enabling measures. Do not try to set right industry and banks, but help industry and banks to set right themselves. The new tool of deregulated approach has to be accepted in solving NPA.

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REASONS FOR THE EXISTENCE A HUGE LEVEL OF NPAS IN THE INDIAN BANKING SYSTEM (IBS): The origin of the problem of burgeoning NPAs 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. To start with, performance in terms of profitability is a benchmark for any business enterprise including the banking industry. However, increasing NPAs 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 borrowers since NPAs 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.

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Some of the other reasons were: After the nationalization of banks sector wise allocation of credit dispercements became compulsory. Banks were compelled to give credit to even those sectors, which were not considered to e very profitable, keeping in mind the federal policy. People in the agricultural sector were hardly interested in returning the loans as they were confident that the loans with the interest would be written off by the successive governments. The small scale industries also availed credit even though they were not sure of performing to the extent of returning the loans. Banks were also not in the position to press enough securities to cover the loans in calls of timings. Even if the assets were provided they proved to be substandard assets as the values that could be realized were very low. Free distribution done during loan mails (congress regime) also contributed to the heavy increase in NPAs. The slackness in effort by the bank authorities to collect or recover loan advances in time also contributes to the increase in NPAs. Lack of accountability of the officers, who sanctioned the loans led to a caste whole approach by the officers recovering the loans.

Loans sanctioned to under servicing candidates due to pressure from the ministers and other politicians also led to the non recovery of debts.

Poor credit appraisal system, lack of vision while sanctioning credit limits. Lack of proper monitoring.
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 Reckless advances to achieve the budgetary targets.

Lack of sincere corporate culture, inadequate legal provisions on foreclosure and bankruptcy.

Change in economic policies/environment. Lack of co-ordination between banks. Some of the internal factors of the organization leading to NPAs are: Division of funds for expansion, diversification, modernization, undertaking new projects and for helping associate concerns, this is coupled with recessionary trends and failure to tap funds in the capital and debt markets. Business failure( product, marketing etc.,),inefficient management, strained labor relations, inappropriate technology, technical problems, product obsolescence etc., Recession , shortage of input, power shortage, price escalation, accidents, natural calamities, besides externalization problem in other countries leading to non payment of overdues. Time/cost overrun during the project implementation stage. Government policies like changes in the excise duties, pollution control orders. Willful default, siphoning off of funds, fraud, misappropriation, promoters/directors disputes etc., Deficiencies on the part of the banks like delay in release of limits and delay in release of payments/subsidies by the government. GLOBAL DEVELOPMENTS AND NPAS:

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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 corporates 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.

INDIAN ECONOMY AND NPAS:

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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 FIs, 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 nonperforming 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.

RESEARCH DESIGN

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Statement of the problem: The Indian commercial banks have come a long way. The development over the years with regards to branch expansion, deposit mobilization of credit facilities and other services has shown tremendous growth and developments. The difficulties and the problems have also increased and one such major problem is NPA. This project is A STUDY ON NPA OF COMMERCIAL BANKS IN INDIA. Objectives: To study the banking operations in general, in India. The study the various reasons for NPA in Indian banking. To analyze different categories of NPAs of selected banks. To compare the efficiency of operations with respect to NPA between public sector banks and private banks/ foreign banks. To study the various steps taken by the banks to bring down the NPAs in respective bank branches. To arrive at methods to bring down NPA to acceptable level. Scope of the study: The study is limited to all banks having NPAs. This report provides as a reference for the net and gross NPAs in public sector banks, private sector banks and foreign banks.

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Research Methodology: Type of research: This research covers all banks operating in India thus making it a descriptive research. Sources of data: The study is mainly based on secondary data; however a general interview with the bank officials has been conducted. Primary data has been generated with the help of the financial statements. Research instruments: Research has been carried out with the help of journals, magazines, articles, newspapers, bank journals and general interview with the bank officials. Methodology: The NPA figures for various banks have been calculated with the help of the financial statements for further analysis . Plan of analysis: In this study quadrant analysis is used on the calculated figures. Limitations: The study is based mostly on secondary data.

Collection of primary data has been difficult due to time and corporate location. It has been generated with the help of secondary data.

Data has been drawn from journals, so information may not be complete. For the analysis only the advances and NPA percentages of banks are taken into consideration. Operational definitions:
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NPA: An asset is classified as non-performing asset (NPAs) if dues in the form of principal and interest are not paid by the borrower for a period of 90 days. Standard Assets: Such an asset is not a non-performing asset. In other words, it carries not more than normal risk attached to the business. Sub-standard Assets: It is classified as non-performing asset for a period not exceeding 18 months Doubtful Assets: Asset that has remained NPA for a period exceeding 18 months is a doubtful asset. Loss Assets: Here loss is identified by the banks concerned or by internal auditors or by external auditors or by Reserve Bank India (RBI) inspection Cash Reserve Ratio (CRR): It 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. Statutory Liquidity Ratio (SLR): It 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. CHAPTER SCHEME

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1. THEORETICAL BACK GROUND: - Contains meaning, reasons and NPAs in commercial banks. It focuses on the gross and the net NPAs in public, private and foreign banks. 2. RESEARCH DESIGN: - Based on the statement of the problem, objectives, scope of the study, limitations, research methodology and operational definitions. 3. INDUSTRY PROFILE: - Introduction to banking industry. This chapter contains history, types, functions and role of banks in economic development structure and performance of Indian banks. It also includes the legal aspect of the Indian banking system. 4. ANALYSIS AND INTERPRETATION: - It is the analysis and overview part of the study. The graphs are based on the tables and so is the analysis. (Quadrant analysis used where the banks are put in 4 quadrants) 5. SUGGESTIONS AND CONCLUSION: - Conclusion can be drawn from the findings and some suggestions are given to control NPAs. 6. ANNEXURES & BIBLIOGRAPHY: -This part deals with the collection of the data. Definition of Banking Business

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Banking as defined in the Section 5 (b) of the Banking Regulations Act, 1949 is the business of "Accepting deposits of money from the public for the purpose of lending or investment". These deposits are repayable on demand or otherwise, and withdrawable by a cheque, draft, order or otherwise. The deposits accepted by Banking Company are different from those accepted by Non Banking Finance Company or any other company in the nature in which these are repayable. Banks are the only financial institutes which can accept demand deposits (Saving / Current) which can be withdrawn by a cheque. Section 6 of Banking Regulations Act, 1949 elaborately specifies the other forms of business which a banking company may carry in addition to banking as defined in section 5. These include in a nutshell

Issuing Demand Drafts & Travellers Cheques Collection of Cheques, Bills of exchange Discounting and purchase of Bills Safe Deposit Lockers Issuing Letters of Credit & Letters of Guarantee Sales and Purchase of Foreign Exchange Custodial Services Investment services doing all such other things as are incidental or conducive to the promotion or advancement of the business of the company;

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Any other form of business which the Central Government may, by notification in the Official Gazette, specify as a form of business in which it is lawful for a banking company to engage.

No banking company shall engage in any form of business other than those referred to above History & Evolution of Indian Banking System: India's banking system has several outstanding achievements to its credit, the most striking of which is its reach. An extensive banking network has been established in the last thirty years, and India's banking system is no longer confined to metropolitan cities and large towns: in fact, Indian banks are now spread out into the remote corners of our country. In terms of the number of branches, India's banking system is one of the largest, if not the largest in the world today. An even more significant achievement is the close association of India's banking system with India's development efforts. The diversification and development of our economy, and the acceleration of the growth process, are in no small measure due to the active role that banks have played in financing economic activities in different sectors. The history of Indian Banking can be identified in three distinct phases 1. Early phase from 1786 to 1969 2. Nationalization of Banks and up to 1991 prior to banking sector Reforms 3. New phase of Indian Banking with the advent of Financial & Banking Sector Reforms after 1991.

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The first phase is from 1786 to 1969, the early phase up to the nationalization of the fourteen largest of Indian scheduled banks. It was also the traditional or conservative phase of Indian Banking. The advent of banking system of India started with the establishment of the first joint stock bank, The General Bank of India in the year 1786. After this first bank, Bank of Hindustan and Bengal Bank came to existence. In the mid of 19th century, East India Company established three banks The Bank of Bengal in 1809, The Bank of Bombay in 1840, and bank of Madras in 1843. These banks were independent units and called Presidency banks. These three banks were amalgamated in 1920 and a new bank, Imperial Bank of India was established. All these institutions started as private shareholders banks and the shareholders were mostly Europeans. The Allahabad Bank was established in 1865. The next bank to be set up was the Punjab National Bank Ltd. which was established with its headquarters at Lahore in 1894 for the first time exclusively by Indians. Most of the Indian commercial banks, however, owe their origin to the 20th century. Bank of India, Central Bank of India, Bank of Baroda, the Canara Bank, the Indian Bank, and the Bank of Mysore were established between 1906 and 1913. The last major commercial bank to be set up in this phase was the United Commercial Bank in 1943. Earlier the establishment of Reserve Bank of India in 1935 as the central bank of the country was an important step in the development of commercial banking in India. The history of joint stock banking in this first phase was characterized by slow growth and periodic failures. There were as many as 1100 banks, mostly small banks, failed during the period from 1913 to 1948. The Government of India concerned by the frequent bank failures in the country

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causing miseries to innumerable small depositors and others enacted The Banking Companies Act, 1949. The title of the Act was changed as "Banking Regulation Act 1949", as per amending Act of 1965 (Act No.23 of 1965). The Act is the first regulatory step undertaken by the Government to streamline the functioning and activities of commercial banks in India. Reserve Bank of India as the Central Banking Authority of the country was vested with extensive powers for banking supervision. At the time of Independence of the country in 1947, the banking sector in India was relatively small and extremely weak. The banks were largely confined to urban areas, extending loans primarily to trading sector dealing with agricultural produce. There were a large number of commercial banks, but banking services were not available at rural and semi-urban areas. Such services were not extended to different sectors of the economy like agriculture, small industries, professionals and self-employed entrepreneurs, artisans, retail traders etc Deficiencies of Indian Banking System before Nationalization Commercial banks, as they were privately owned, on regional or sectarian basis resulted in development of banking on ethnic and provincial basis with parochial outlook. These Institutions did not play their due role in the planned development of the country. Deposit mobilization was slow. Public had less confidence in the banks on account of frequent bank failures. The savings bank facility provided by the Postal department was viewed a comparatively safer field of investment of savings by the public. Even the deficient savings thus mobilized by commercial banks were not channeled for the development of the economy of the country. Funds were largely
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given to traders, who hoarded agricultural produce after harvest, creating an artificial scarcity, to make a good fortune in selling them at a later period, when prices were soaring. The Reserve Bank of India had to step in at these occasions to introduce selective credit controls on several commodities to remedy this situation. Such controls were imposed on advances against Rice, Paddy, Wheat, Other food grains (like jowar, millets, ragi etc.) pulses, oilseeds etc. Initial Phase of Nationalization: When the country attained independence Indian Banking was exclusively in the private sector. In addition to the Imperial Bank, there were five big banks each holding public deposits aggregating Rs.100 Crores and more, viz. the Central Bank of India Ltd., the Punjab National Bank Ltd., the Bank of India Ltd., the Bank of Baroda Ltd. and the United Commercial Bank Ltd. Rest of the banks were exclusively regional in character holding deposits of less than Rs.50 Crores. Government first implemented the exercise of nationalization of a significant part of the Indian Banking system in the year 1955, when Imperial Bank of India was Nationalized in that year for the stated objective of "extension of banking facilities on a large scale, more particularly in the rural and semi-urban areas, and for diverse other public purposes" to form State Bank of India. SBI was to act as the principal agent of the RBI and handle banking transactions of the Union & State Governments throughout India. The step was in fact in furtherance of the objectives of supporting a powerful rural credit cooperative movement in India and as recommended by the "The All-India Rural Credit Survey Committee Report, 1954". State
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Bank of India was obliged to open an accepted number of branches within 5 years in unbanked centers. Government subsidized the bank for opening unremunerative branches in non-urban centers. The seven banks now forming subsidiaries of SBI were nationalized in the year 1960. This brought one-third of the banking segment under the direct control of the Government of India. The major process of nationalization was carried out on 19th July 1969, when the then Prime Minister of India, Mrs.Indira Gandhi announced the nationalization of 14 major commercial banks in the country. One more phase of nationalization was carried out in the year 1980, when seven more banks were nationalized. This brought 80% of the banking segment in India under Government ownership. The country entered the second phase, i.e. the phase of Nationalized Banking with emphasis on Social Banking in 1969/70. Chronology of Salient steps by the Government after Independence to Regulate Banking Institutions in the Country 1. 1949 : Enactment of Banking Regulation Act.

2. 1955(Phase I) : Nationalization of State Bank of India 3. 1959(Phase II) : Nationalization of SBI subsidiaries 4. 1961 6. 1971 7. 1975 200 crores. : Insurance cover extended to deposits : Creation of credit guarantee corporation : Creation of regional rural banks 5. 1969(Phase III) : Nationalization of 14 major banks

8. 1980(Phase IV) : Nationalization of seven banks with deposits over

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Composition of Indian Banking System The banking system has three tiers. These are the scheduled commercial banks; the regional rural banks which operate in rural areas not covered by the scheduled banks; and the cooperative and special purpose rural banks. There are approximately 80 scheduled commercial banks, Indian and foreign; almost 200 regional rural banks; more than 350 central cooperative banks, 20 land development banks; and a number of primary agricultural credit societies. In terms of business, the public sector banks, namely the State Bank of India and the nationalized banks, dominate the banking sector. At present the number of nationalized banks is 20. Several Foreign banks were allowed to operate as per the guidelines of RBI. At present the banking system can be classified in following categories: PUBLIC SECTOR BANKS:

State Bank of India and its 7 associate Banks Nationalized Banks (20 in number) Regional Rural Banks sponsored by Public sector Banks

PRIVATE SECTOR BANKS:

Old Generation Private Banks New Generation Private Banks Foreign Banks in India Scheduled Co-operative Banks Non Scheduled Banks

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CO-OPERATIVE SECTOR BANKS:

State Co-operative Banks Central Co-operative Banks Primary agriculture Credit Societies Land Development Banks Urban Co-operative Banks State Land Development Banks

DEVELOPMENT BANKS:

Industrial Finance Corporation of India (IFCI) Industrial Development bank of India (IDBI) Industrial Credit & Investment corporation of India (ICICI) Industrial Investment Bank of India (IIBI) Small Industries Development Bank of India (SIDBI) National Bank for Agriculture & Rural Development (NABARD) Export-Import Bank of India India had a fairly well developed commercial banking system in

existence at the time of independence in 1947. The Reserve Bank of India (RBI) was established in 1935. While the RBI became a state owned institution from January 1, 1949, the Banking Regulation Act was enacted in 1949 providing a framework for regulation and supervision of commercial banking activity. Since the study is based on the existence of NPAs in banking sector we will now look into some of the aspects related to it.

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RBI GUIDELINES ON INCOME RECOGNITION (INTEREST INCOME ON NPAs) In the peak crisis period in early Nineties, when the first Series of Banking Reforms were introduced, the working position of the State-owned banks exhibited the severest strain. Commenting on this situation the Reserve Bank of India has pointed out as under: "Till the adoption of prudential norms relating to income recognition, asset classification, provisioning and capital adequacy, twenty-six out of twenty-seven public sector banks were reporting profits (UCO Bank was incurring losses from 1989-90). 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 net 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." Consequently PSBs in the post reform period came to be classified under three categories as

healthy banks (those that are currently showing profits and hold no accumulated losses in their balance sheet) banks showing currently profits, but still continuing to have accumulated losses of prior years carried forward in their balance sheets Banks which are still in the red, i.e. showing losses in the past and in the present.

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Banks recognize income including interest income on advances on accrual basis. That is, income is accounted for as and when it is earned. The prima-facie condition for accrual of income is that it should not be unreasonable to expect its ultimate collection. However, NPAs involves significant uncertainty with respect to its ultimate collection. Considering this fact, in accordance with the guidelines for income recognition issued by the Reserve Bank of India (RBI), banks should not recognize interest income on such NPAs until it is actually realized.

RBI guidelines on classification of bank advances:

Reserve Bank of India (RBI) has issued guidelines on provisioning requirement with respect to bank advances. In terms of these guidelines, bank advances are mainly classified into: Standard Assets: Such an asset is not a non-performing asset. In other words, it carries not more than normal risk attached to the business. Sub-standard Assets: It is classified as non-performing asset for a period not exceeding 18 months Doubtful Assets: Asset that has remained NPA for a period exceeding 18 months is a doubtful asset. Loss Assets: Here loss is identified by the banks concerned or by internal auditors or by external auditors or by Reserve Bank India (RBI) inspection.

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In terms of RBI guidelines, as and when an asset becomes a NPA, such advances would be first classified as a sub-standard one for a period that should not exceed 18 months and subsequently as doubtful assets. It should be noted that the above classification is only for the purpose of computing the amount of provision that should be made with respect to bank advances and certainly not for the purpose of presentation of advances in the banks balance sheet. The Third Schedule to the Banking Regulation Act, 1949, solely governs presentation of advances in the balance sheet. Banks have started issuing notices under the Securitization Act, 2002 directing the defaulter to either pay back the dues to the bank or else give the possession of the secured assets mentioned in the notice. However, there is a potential threat to recovery if there is substantial erosion in the value of security given by the borrower or if borrower has committed fraud. Under such a situation it will be prudent to directly classify the advance as a doubtful or loss asset, as appropriate. RBI GUIDELINES ON PROVISIONING REQUIREMENT OF BANK ADVANCES Reserve Bank of India (RBI) has issued guidelines on provisioning requirements of bank advances where the recovery is doubtful. Banks are also required to comply with such guidelines in making adequate provision to the satisfaction of its auditors before declaring any dividends on its shares. In case of loss assets, guidelines specifically require that full provision for the amount outstanding should be made by the concerned bank. This is
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justified on the grounds that such an asset is considered uncollectible and cannot be classified as bankable asset. Also in case of doubtful assets, guidelines requires the bank concerned to provide entirely the unsecured portion and in case of secured portion an additional provision of 20%-50% of the secured portion should be made depending upon the period for which the advance has been considered as doubtful. For instance, for NPAs which are up to 1-year old, provision should be made of 20% of secured portion, in case of 1-3 year old NPAs up to 30% of the secured portion and finally in case of more than 3 year old NPAs up to 50% of secured portion should be made by the concerned bank. In case of a sub-standard asset, a general provision of 10% of total outstanding should be made. Reserve Bank of India (RBI) has merely laid down the minimum provisioning requirement that should be complied with by the concerned bank on a mandatory basis. However, where there is a substantial uncertainty to recovery, higher provisioning should be made by the bank concerned.

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.

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On the other hand managing credit risk is a much more forwardlooking 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.

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 borrowers viability. However, the approach 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.

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Capital Adequacy Ratio (CAR) of RBI and Basel committee on banking supervision (BCBS):
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 was 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 infact helps bank to provide protection to the depositors and the creditors.
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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. IMPACT OF EXCESS LIQUIDITY: 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

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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 corporates. As such, though in its monetary policy RBI announces rate cut but, such news are no longer warmly greeted by the bankers. HIGH COST OF FUNDS DUE TO NPAs: Quite often genuine borrowers face the difficulties in raising funds from banks due to mounting NPAs. 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 lenders losses caused due to high level of NPAs. Therefore, quite often corporates 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 Securitization 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 and the financial institution, the secured assets

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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 be 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.

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NPA in Indian Banks-Year 2002-03 - Review at the end of A Decade. Indian Banking in 2002 represents a sea change from what it was a decade back. It is a decade of Professional banking moving towards Global Standards. NPA in 1992-93 was a nightmare. Today it is still a problem (albeit a major problem, but under process of firm control). The Government of India is not recapitalizing PSBs in 2001-02, though it released the last installment of an earlier committed amount to Indian Bank (a single case). Banks in general have performed extremely well in 2001-02. There are no public sector banks termed as "weak Bank" today. PSBs now are in a mood to compete and face competition form private & foreign Banks. In 1992-93, "the profitability of the PSBs as a group turned negative with as many as twelve nationalized banks reporting net 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 Limit." The public sector banks which suffered losses of Rs.3, 293 crores in 1992-93 and Rs.4, 349 crores in 1993-94, i.e. in the initial years of introduction of prudential norms, have ended the year 1997-98 with a net profit of Rs.5027 crores. Net NPAs of public sector banks formed 8.2% of the net advances and 3.3% of the total assets as at the end of March 1998.

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Corresponding figures as at 31.03.2002 is 5.82% and 2.42%. PSBs recorded an aggregate net profit of Rs.8, 301.24 Crores in 2001-02. NPAs as at 2001-2002 group-wise can be seen from this Table:

Non-Performing Assets as Percentage of Total Assets - All Scheduled Commercial Banks Sr No Name of the Bank Gross NPAs/Total Asset Net NPAs/Total Assets

199899 1 Nationalized Banks 2 State Bank Group 3 Total PSBs 4 Private Sector Banks (old) 5 Private Sector Banks (new) 6.83 6.52 6.71 5.78 2.26 3.10

19992000 6.0 5.88 5.95 5.22 1.60 3.16

200001 5.44 5.11 5.31 5.14 2.05 3.04

2001-02 5.21 4.39 4.89 5.20 3.91 2.43

199899 3.26 2.94 3.14 3.56 1.59 1.10

1999- 2000-01 2000 3.15 2.60 2.94 3.27 1.08 1.03 2.95 2.35 2.72 3.28 1.18 0.77

2001-02 2.16 2.00 2.42 3.22 2.10 0.82

6 Foreign Banks

Various measures introduced since 1993 to arrest and contain the growth of NPAs are described below:
1. Dismantling of controls and deregulation of working of commercial

banks, permitting entry of new private sector Banks and permission for Foreign Banks to open more branches are steps that were carried out under Banking Sector Reforms. These steps had the effect of opening Indian Banking to Global standards by making them to function efficiently in a competitive environment. This is the initial step to create a structural framework for the public sector banks to

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enable them to adjust to the new environment and turn into dynamic and self-reliant operating units.
2. The process of deregulation freed the banks from the control of the

Finance Ministry and RBI. Reserve Bank of India, hereafter, acts not as a controller, but a regulator. In the year 1994 RBI further fine-tuned the process by constituting a separated a Board of Financial Supervision with the objective of segregating the supervisory role from the regulatory functions of RBI. Banks now operate independently in a competitive financial market, but have to comply with prudential norms and safeguards essential for their well-being. They have to report due compliance to RBI. Complete particulars about system of Supervision of Financial Institutions by RBI in the Post Reforms Period (since 1994) are summarized in web-page Supervision of the Indian Financial System by Reserve Bank of India
3. RBI in the year 1993 introduced prudential norms as conveyed by

Basel Accord of 1988 applicable to Indian banks. These included standards relating to Capital Adequacy, Income Recognition, Asset Classification and Provisioning for non-performing assets. These are detailed in web-page Capital Adequacy Standards - Basel Accord, 1988. This had the effect of providing a much needed transparency with regards to the state of affairs of each bank and enabled instant corrective measures to be executed.
4. Avenues of New Recovery Forums/strategies: DRTS were made more

functional to dispose of pending litigation quickly. More DRTS and DARTs were established. Banks were encouraged to avail the forum of Lok Adalats for quick settlement of overdues under small loans. A number of one time settlement schemes were approved by RBI to
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promote compromise settlements for different categories of borrowers. The Recovery of Debts due to Banks and Financial Institutions (amendment) Act, passed in March 2000 has helped in strengthening the functioning of DRTs. Provisions for placement of more than one Recovery Officer, power to attach defendant's property/assets before judgment, penal provisions for disobedience of Tribunal's order or for breach of any terms of the order and appointment of receiver with powers of realization, management, protection and preservation of property are expected to provide necessary teeth to the DRTs and speed up the recovery of NPAs in the times to come. Though there are 22 DRTs set up at major centers in the country with Appellate Tribunals located in five centers viz. Allahabad, Mumbai, Delhi, Calcutta and Chennai, they could decide only 9814 cases for Rs.6264.71 crores pertaining to public sector banks since inception of DRT mechanism and till September 30, 2001.The amount recovered in respect of these cases amounted to only Rs.1864.30 crores.
5. Banks were permitted to seek infusion of fresh equity from the public

retaining Government share of equity capital at 51%. A number of PSBs entered the market and raised Tier I and Tier II capital accordingly. Their public issues are now listed in Stock Exchanges. This has created a new class of stake-holder (albeit share-holders) vitally interested in the well-being of the banks and qualified/empowered to question the Board of Directors at the appropriate forum. Annual General Meetings hence forth for the PSBs cannot be a tame show.
6. Asset Reconstruction & Securitization: The suggestion for creation of

Asset Reconstruction Company to tackle problem of hangover of piled

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up past NPAs was first suggested by Narasimhan Committee Report II. To quote there from - "An important aspect of the continuing reform process is thus to reduce further the high level of NPAs as a means of institutional strengthening. While there is reason to expect that with a combination of policy and institutional development, new NPAs could in future be lower than hitherto, the problem remains of the huge backlog of existing NPAs which impinges severely on banks performance and their profitability. Several approaches are possible. The earlier Committee had suggested the creation of an Assets Reconstruction Fund (ARF) to take these assets off banks books at a discount. Recapitalization through infusion of capital is another approach and has been used in the case of some banks. In the last six years massive budgetary funds have been used for recapitalization of public sector banks. This a costly and over time, not a sustainable option. The problem, however, remains and consideration would need to be given to revisiting the concept of an ARF." The Ordinance for creation of ARCs for recovery of NPAs of Banks was passed during June 2002 and this was upgraded as an Act of the Parliament in December 2002. This is an important measure, as handicaps posed by the infirmities of the legal system were undone
7. Prompt Corrective Action: PCA is a regulatory and remedial

mechanism and correctional strategy designed by RBI, intended for implementation towards resurrecting a commercial bank that exhibits symptoms of a progressive downward trend in its operational parameters and quality of assets. It diagnoses and identifies the symptoms of an impending crisis developing in the banking institution and responds towards arresting and preventing further decadence on
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the one hand and promoting quick resurgence through timely restorative measures.
8. Norms of Lenders' Liability: While successfully piloting the "The

Securitization

and

Reconstruction

of

Financial

Assets

and

Enforcement of Security Interest Bill" in the houses of the Parliament by way of moderating the possible misuse of the powers under the legislation by Banks and Financial Institutions, the Finance Minister gave an assurance to bring out a code of Fair Practices defining Lenders Liability to the borrowers in respect of loans and advances extended by them. Consequent to the assurance by the Finance Minister, RBI during December, 2002 has come out with broad guidelines for framing the Fair Practices Code with regard to lenders' liability to be followed by commercial banks and financial institutions, emphasizing on transparency and proper assessment of borrowers' credit requirements". RBI has issued a draft of the model code and has advised the individual banks to adopt model guidelines for framing their respective Fair Practices Code with the approval of their Boards.
9.

Risk Assessment & Risk Management: Risk management is a discipline for dealing with the possibility that some future event will cause harm. It provides strategies, techniques, and an approach to recognizing and confronting any threat faced by an organization in fulfilling its mission. There can be minimum risk in a captive controlled economy, where industry is protected by high tariff walls and banks by directed credit and directed interest rates, and directed investments. But along with such minimum risk, there would also be minimum growth of the economy. In India after total regulation for
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several decades, the economy witness around 3% average growth. The Indian economy has now been freed of State controls. Consequently in today's corporate world, it is a challenge for corporate leaders to run a business with the objective of maximizing shareholders' value. The changing environment, on account of on-going process of liberalization and reforms all round, of easing of import restrictions, resulting in an emerging new economic order increases risks content whilst also unfolding new opportunities. In this environment while decision making is the prerogative of the management, sound risk management is also their prime responsibility - as it provides them with the frame work to proactively identify and manage risk associated with their decisions. Banks in the process of financial intermediation are confronted with various kinds of financial and non-financial risks viz., credit, interest rate, foreign exchange rate, liquidity, equity price, commodity price, legal, regulatory, reputation, operational, etc. These risks are highly interdependent and events that affect one area of risk can have ramifications for a range of other risk categories. It therefore becomes very essential for top management of banks to attach considerable importance to improve the ability to identify measure, monitor and control the overall level of risks undertaken. This is a new development in Indian Banking. All these decades before the advent of Reforms the exercise of risk assessment and risk management were never seriously considered or attempted, as the banks were operating in a captive economy.

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Since the year 1998 RBI have been giving serious efforts and attention towards evolving suitable and comprehensive models for Riskmanagement by the Banks and to integrate this new discipline in the working systems of the Banks. RBI has identified risk-prone areas in Asset-Liability Management, Credit Management, Changes in Market conditions and counter-party & Country Risks and has evolved suitable models for managing all such risk. RBI has also evolve a system of Risk based Supervision Banks. It also advised banks a parallel scheme for carrying out internal audit based on risk perception. 10. E-Banking & VRS: The influence of these areas of banking reforms may not appear directly relevant for handling reduction of NPAs. But computerization provides for data-accuracy and operational efficiency and results in better Management Information Service. VRS rationalizes the work force, which in turn results in better productivity and operational efficiency.

Present Prudential Regulations:

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"The prudential norms on income recognition, asset classification and provisioning thereon, are implemented from the financial year 1992-93, as per the recommendation of the Committee on the Financial System (Narasimhan Committee I). These norms have brought in quantification and objectivity into the assessment and provisioning for NPAs. We at the central bank constantly endeavor to ensure that our prescriptions in this regard are close to international norms. We are neither strict nor lax but just correct in tune with our needs and capabilities. "Under the prudential norms laid down by RBI

Income should not be recognized on NPAs on accrual basis but should be booked only when it is actually received in respect of such accounts. An asset is considered as "non-performing" if interest or installments of principal due remain unpaid for more than 180 days (the lag would get reduced to 90 days from March 31, 2004 to conform to international norms). Any NPA would migrate from sub-standard to doubtful category after 18 months (as against 12 months under international norms). It would get classified as loss asset if it is irrecoverable or only marginally collectible. The banks should make full provision for loss assets, 100 per cent of the unsecured portion of the doubtful asset plus 20 to 50 per cent of the secured portion (depending on the period for which the account is doubtful), and a general 10% (it is 20 per cent under international norms) of the outstanding balance in respect of sub-standard assets."

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"Detailed guidelines have been issued by RBI in October 2000 on valuation

and provisioning for investment portfolio including credit substitutes" While NPA cannot be eliminated, but can only be contained, it has to be done not at a heavy cost of provisioning and increasing the portfolio of credit. Along with recovery fresh inflow of NPA should be brought down at a level much less than the quantum of its exit. If this specific goal is reached, there is an eventual solution for this problem. THE NARASIMHAN COMMITTEE'S FIRST REPORT The salient features of these reforms include:

Phasing out of statutory pre-emption - The SLR requirement have been brought down from 38.5% to 25% and CRR requirement from 7.50% to 5.75%. (Presently 4.5%) Deregulation of interest rates - All lending rates except for lending to small borrowers and a part of export finance have been de-regulated. Interest on all deposits are determined by banks except on savings deposits. Capital adequacy - CAR of 9 % prescribed with effect from March 31, 2000. Other prudential norms - Income recognition, asset classification and provisioning norms has been made applicable. The provisioning norms are more prudent, objective, transparent, and uniform and designed to avoid subjectivity. Debt Recovery Tribunals - 22 DRTs and 5 DRATs have already been set up and 7 more DRTs will be set up during the current financial

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year. Comprehensive amendment in the Act have been made to make the provisions for adjudication, enforcement and recovery more effective.

Transparency in financial statements - Banks have been advised to disclose certain key parameters such as CAR, percentage of NPAs, provisions for NPAs, net value of investment, Return on Assets, profit per employee and interest income as percentage to working funds. Entry of new private sector banks - 9 new private sector banks have been set up with a view to induce greater competition and for improving operational efficiency of the banking system. Competition has been introduced in a controlled manner and today we have nine new private sector banks and 36 foreign banks in India competing with the public sector banks both in retail and corporate banking Functional autonomy - The minimum prescribed Government equity was brought to 51%. Nine nationalized banks raised Rs.2855 crores from the market during 1994-2001. Banks Boards have been given more powers in operational matters such as rationalization of branches, credit delivery and recruitment of staff. Hiving off of regulatory and supervisory control - Board for financial supervision was set up under the RBI in 1994 bifurcating the regulatory and supervisory functions.

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NARASIMHAN COMMITTEE- SECOND REPORT The Narasimhan Committee on Banking Reforms, in its second report, has combined drastic surgery with a strong dose of medicine to cure the ailing industry. On-performing assets (NPAs) have been the bane of the industry. The panel has identified poor credit decisions by managements, cyclical changes in the economic environment, directed credit and crude forms of behest-lending as the factors responsible for poor asset quality. The panel points a finger at priority sector credit as having a high contamination coefficient and suggests that quantitative targets have caused erosion of asset quality. It laments the fact that infusion of recapitalization funds notwithstanding, NPAs remain uncomfortably high. Yet it recommends that advances covered by government guarantees that have turned sticky should also be reckoned as net NPAs. The Narasimhan Committee's solution for NPAs is the creation of an Asset Reconstruction Fund (ARF), which will take over the bad debts of banks from their balance sheets to enable them to start on a clean slate. Recapitalization through budgetary infusion, the panel correctly points out, is not a sustainable option. But bankers are skeptical about the workability of the ARF. A senior banker asked, "At what price will the ARF take over my NPAs? How will the discount be worked out?" He said that the ARF cannot bail out banks under the present legal system. Although every bad debt is secured, banks cannot encash the security because of legal hurdles. The Urban Land Ceiling Act is a major deterrent to debt recovery. Bankers say that the legal system has to be revamped to facilitate recovery so that the ARF can pick up "NPAs at a viable price".

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The committee has recommended that net NPAs be brought down to less than 5 per cent by the year 2000 and 3 per cent by the year 2002. "Easier said than done," says a top banker. "Already we do a lot of window-dressing. Outstanding accounts are shown as priority lending to meet targets. We keep lending to defaulters to roll over the NPAs. Fixing unrealistic targets will be counterproductive." The committee has recommended that banks should not lend to defaulters, but bankers say that this is unrealistic. They claim that in the absence of fresh loans, the defaulting companies will close down, and leading to loss of jobs. "Will that be acceptable?" asks a banker. Bankers also complain that they are forced by the Board for Industrial and Financial Reconstruction (BIFR) to lend to sick companies, yet more often than not there is no turnaround and the accounts turn bad. Focus at Anomalies at the Credit Delivery Centre: NPA can be defined as failed credit. The service product has turned into scrap. Credit delivered is not put to productive application, but sunk into dead assets. But where has the process gone wrong? Has the credit delivered correctly, properly and sincerely? Has NPA surfaced due to defective product engineering by the designer (Banker) or due to misapplication of the product by the user (credit-customer), or due to effects of the violently changing economic/ industrial /commercial environment? The exact stage at which the failure has occurred, which causes NPA in the life cycle of a project-finance can be identified in a post-mortem review. How a credit given to an eligible and deserving customer for a viable

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project can ever become NPA, if it was efficiently assessed and disbursed resulting in its successful completion and realization of project objectives? Can it be only due to 'willful default' by a credit customer at the last stage? Obviously if the credit is not allowed to a deserving, or eligible customer and it turns sticky, the financing bank is as much to be blamed as the customer. Similarly if the project financed is deficient and not viable or credit-worthy, it is a mistake of judicious assessment by the bank. The disbursement of project finance is not done efficiently; it may result in time/cost over runs and lead to trouble to the financing institution. In all these cases it is deficiency of job talents on the part of the banker, which creates NPAs. NPA can be arrested only through internal remedies, i.e. improving efficiency of credit assessment and credit delivery operations at the point of the financing bank in the first instance. Followed by efficient utilization credit disbursement by industry and trade. Looking next at the customer what is the benefit or motive of the corporate customer to willfully default repayment? And why this tendency has surfaced amongst Indian corporates in the last two decades? A project is deemed implemented successfully when it not only attains profitable turnover but also discharges the project-debt as per schedule. Debt default and successful entrepreneurship in business promotion do not go together. The assets created in the project are encumbered to the lender and discharging the debt releases the assets from the banker's charge. The corporate customer proves his capacity and financial integrity and he commands better recognition by the banker for his future credit needs only when the project is shown as self repaying its debts. Still why default takes

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place and that too willfully? This is apparently against the laws of economics and law of human nature. Credit is a product of financial service, which provides redeemable capital to industry and business. Commencing with borrowed capital a viable project generates the source for its repayment and reaches the stand-alone or self-sustaining status. Primarily there are three stages in credit extension, its productive use and its repatriation. These are, credit delivery, credit utilization and loan liquidation. Unless you are successful in the earlier stage, you do not reach the next stage. Thus if the project report and the terms of loan sanction are not handled realistically, the credit cycle will not pass on to the next stage of successful project implementation. If the project is not effectively implemented it is futile to aspire for repayment in the normal course, without the loan becoming an NPA. The credit customer need not have to search for a source to repay the loan. The source for repayment is self-generated from within and made available in time schedules coinciding with the repayment terms. The provision is in-built in the project structure. The bank-credit should be for productive and self-redeemable projects and should thus be self-liquidating. This then is the test for a viable project and the grounds on which the banker accepts to finance the same. The banker has to possess different knowledge resources and talents to efficiently handle credit-management at each stage. In particular the banker needs to have two primary attributes for successful credit extension. These are talent (appropriate knowledge and foresight) and integrity. The customer must possess entrepreneur ability and integrity. We may call it as two 'C's (character and capacity) to be present commonly with the financier and promoter. These are the human factors. Additionally the
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project financed needs to possess two characteristics, technical feasibility and financial viability. If the basic ingredients are lacking in the banker, the loan released by him will not be productively employed and it may result in potential NPA. Decades back credit risk was not so extensive, when banking was operated purely on a security-oriented approach. Accept and hold in your custody a marketable security and release the advance. Allow the activity to be carried out by the customer. Release the security when repayment is made, and in case of non-repayment dispose of the security and reimburse your exposure. It is almost zero risk oriented. Subsequently when the country was industrialized in the 60s industry was protected by the government policies. Imports were discouraged. Units enjoyed a captive demand without competition and hence there was no problem for the banker. But it is not so today, when banks are called upon to extend multiple types finance for diverse needs of capital for industry, business and other economic activities open to global competition. Character and capacity is still the basic ingredient, but essence of these terms has acquired substantial additional content and meaning. The action or initiative is with the customer at the stage of the preparation of the project. It is with the banker in project appraisal and loan sanction including the setting up of terms and conditions. If both act prudently the first stage is passed. In the second stage the implementation responsibility is with the customer and controlling responsibility with the banker. In the final stage it is mainly the responsibility of the customer. A

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healthy joint approach promotes the cause of both, the absence of which can ruin either or both. The analysis of NPA should indicate whether the roots of NPA lie in the first, second or third stages of the life span of the service product. Wrong handling at any stage can obviously create NPA. Credit, which undergoes infant-mortality at the outset itself or after a short span of time after trial production, is on account of deficiency in credit assessment and credit delivery. The loan is released, but not utilized for the purpose it was allowed and no assets are held or only negligible assets are seen. The seeds are sown but the plants never sprout and there is no question of the crops to harvest. This can be attributed to gross negligence, inefficiency or lack of training and knowledge and finally lack of integrity in respect of the person(s) involved. These are the within factors responsible for accretion to the pool of Bank's NPA burden- lack of talent and lack of integrity. Failure in the second stage is generally on account of default on the part of the banker in carrying out his functions with foresight and wisdom. This goose will lay the golden eggs, but without waiting, if you cut the goose out of eagerness for a quick meal, it results in a sordid plight for the person of hasty action. There are two manifestos for the branch manager, i.e. the Project Report and the Memorandum of Loan Sanction by a higher authority stipulating terms and conditions. In other words this is the outer limit of the delegated authority for the Bank Manager in the exercise of credit management with reference to this customer. It is also a contract between the financing bank and the borrowing customer. The project report is the source document and the loan sanction record is a derived instrument. The sanction should be based on the project report, and if this is not so and if
54

the sanction is at variance, the project report must be revised and approved/accepted by all. Once a letter of sanction is received, the existence of the project report is forgotten and the assumptions contained therein are totally ignored. No doubt the sanctioned terms represent the legal contract between the credit customer and the banker, but the project report alone contains nucleus for the successful culmination of the activity and creating the source for repayment. During implementation of the project in the second stage involving disbursement of funds progress may not take place as scheduled in the project. The situation needs a flexible attitude on the part of the Bank manager, but if rigid adherence is resorted to the terms of sanction, it brings adverse effects to the detriment of the interests of both the banker and the credit customer. These problems were not felt so much earlier, when in the inflationary economy, when the security financed was regularly appreciating in value, and marketing the products produced, even of inferior quality was never felt a problem in a captive and protected market. A concrete example can explain this. The project outlay is Rs.5 Lacs. Credit customer equity is Rs.2.0 Lacs and Bank loan Rs.3.0 Lacs. Credit customer's equity includes margin for working capital Rs.50,000/-.The Loan was to be released in January 2003 and the project to be completed in the same year. The interest and first installment to be repaid before March 2004. Now there is delay initially in the bank completing the documents and other legal formalities and the loan was released only in March 2003. On the credit customers part there is delay of three months in the completion of the project. However the credit customer on his part did bring Rs.25000 additionally. Now events as they have unfolded are at variance with the assumptions in the project report. Thus the implementation report is different

55

from the project in certain details. As at 31st March 2004, when the project is still incomplete, the bank manager arbitrarily recovers the first installment and interest, as per the terms of sanction. If this happens, it is then woe to the project, which is still incomplete. The unit financed faces liquidity crunch due to contraction in working capital caused by term loan repayment there from and is unable to either complete the project or provide the margin and avail the working capital. Here the bankers switch to the 3rd stage in the life cycle, while the second stage is still incomplete. Recovery can come only from generated funds and not from the source of finance for the project. Two decades of regimented banking and directed approach to credit delivery has deprived bank managers of the instinct skill and knowledge. Lack of structured career path and restricted experience through vertical movement in the hierarchical ladder without a horizontal exposure and without imparting training in organization and business management needed for a understanding and for the interpretation of the current business environment, are the sins of a blind promotion policy more oriented on subjectivity than objective merit assessment. Nationalized banking did not produce a spring of talent resources from within. Directive Inputs and course-direction came externally from RBI and Finance Ministry. Execution responsibility was delegated to the nationalized banks. The system did not promote initiative and talent, but bred corruption and nepotism. Before nationalization banks were in the private sector. Indian banking developed on ethnic and regional set-up. Every community and every section wanted to start a bank. The entire social set up was based on the joint Hindu family culture and the business looked to class banking for a select segment of society. Banking was not professionalized, as was major business and

56

industry, which utilized bank finance. The trader in the Mandi, the rice and cotton and oil miller did not believe that professional education is necessary for doing business. So too did bankers. The average bank employee, including a part of the top executives did have no professional education or education in modern management techniques. Bureaucratic approach and lack of talent in the service provider can also generate NPA. That happens when a project is grossly under-financed. It will also happen when the project initially is scrutinized at the lower level and found viable based on well-defined assumptions, but when finally sanctioned at a higher level, several stipulations like higher rate of interest or higher margin requirement on the credit customer stipulated like condition to raise additional internal finance by way of unsecured loans were included without looking into the feasibility and sensitivity of the variations on the overall viability of the project. Loyalty to the top man (CEO) and understandings his mind and acting as per his dictates and desires is considered as a main service-ethics. Corporate management in India is generally a one-man dominated show. This is the legacy of the spirit of the patriarch in the decade-old joint-family culture, which however has vastly dismantled. This management philosophy is against modern management concepts of defining a goal and mission for the organization. An individual is fragile and fickle minded. In the modern world, where consumerist motives predominates in the minds of all, his Value systems are not dependable. Instead of loyalty to the mission and goals of the organization, it turns to be loyalty to the top boss, and to every top boss changing in intervals of 3 to 5 years. This is the scene of

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Indian Banking struggling hard to transition from old primitive systems and values to modern professional Business Ethics and Corporate Governance.

The Emergence of NPA in Indian Banking & Financial Institutions and its Dimensions:
Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in our country sending distressing signals on the sustainability and endurability of the affected banks. The positive results of the chain of measures affected under banking reforms by the Government of India and RBI in terms of the two Narasimhan Committee Reports in this contemporary period have been neutralized by the ill effects of this surging threat. Despite various correctional steps administered to solve and end this problem, concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on banking and financial institutions. The severity of the problem is however acutely suffered by Nationalized Banks, followed by the SBI group, and the all India Financial Institutions.

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Table No. I NPA Statistics -All Scheduled Commercial Banks (Amount in Crores)
%-age of Gross NPA to total advances 14.4 14.7 12.7 11.4 %-age of Net NPA to net advances 7.3 7.6 6.8 6.2

Year

Total Advances

Gross NPA

Net Advances

Net NPA

1998-1999 1999-2000 2000-2001 2001-2002

352697 399496 475113 558766

50815 58722 60408 63883

325522 367012 444292 526329

25734 27892 30211 32632

As at 31.03.2002 the aggregate gross NPA of all scheduled commercial banks amounted to Rs.63, 883 Crores. Table No. I give the figures of gross and net NPA for the last four years. It shows an increase of Rs.13, 068 Crores or more than 25% in the last financial year, indicating that fresh accretion to NPA is more than the recoveries that were affected, thus signifying a losing battle in containing this menace. The apparent reduction of gross NPA from 14.4% to 11.4% between 1999 and 2002 provides little comfort, since this accomplishment is on account of credit growth, which was higher than the growth of Gross NPA and not through appreciable recovery of NPA. There is neither reduction nor even containment of the threat. The gross NPA and net NPA for PSBs as at 31.03.2002 are 12.39% and 6.74% are higher than the figures for SCBs at 11.4%and 6.2%.

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Comparative figures for PSBs, SBI Group and Nationalized Banks are as under.
Table -2: NPA of PSBs (Amount in Crores)
%-age of Gross NPA to total advances 17.8 % 16.0 % 15.9 % 14.00 % 12.39 % %-age of Net NPA to net advances 9.2 % 8.2 % 8.1 % 7.9% 6.74%

Year

Total Advances Gross NPA Net NPA

1997-1998 1998-1999 1999-2000 2000-2001 2001-2002

244214 284971 325328 380077 442134

43577 45563 51710 53033 54773

20285 21232 24211 26188 27967

Table -3: NPA of State Bank Group

Year 1998-1999 1999-2000 2000-2001 2001-2002

(Amount in Crores)
%-age of Gross %-age of Net

Total Advances Gross NPA Net NPA NPA to total NPA to net 113360 118959 129253 150390 15522 18641 19773 20586 6829 7764 7411 8125 advances 14.57% 15.67 % 14.08 % 12.73 % advances 6.98 % 7.74 % 6.77 % 6.26 %

Table -4: NPA of Nationalized Banks.

Year 1998-1999 1999-2000 2000-2001 2001-2002

(Amount in Crores)
%-age of Gross %-age of Net

Total Advances Gross NPA Net NPA NPA to total NPA to net advances advances

166222 188926 224818 264237

30130 33069 33521 34609

14441 15759 17399 16096

16.88 16.02 13.99 12.19

8.91 8.35 7.80 7.01

Further it is revealed that commercial banks in general suffer a tendency to understate their NPA figures. There is the practice of 'ever-greening' of advances, through subtle techniques. As per report appearing in a national daily the banking industry has under-estimated its non-performing assets

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(NPAs) by whopping Rs. 3,862.10 Crores as on March 1998. The industry is also estimated to have under-provided to the extent of Rs 1,412.29 Crores. The worst "offender" is the public sector banking industry. Nineteen nationalized banks along with the State Bank of India and its seven associate banks have underestimated their NPAs by Rs 3,029.29 Crores. Such deception of NPA statistics is executed through the following ways.

Failure to identify an NPA as per stipulated guidelines: There were instances of `sub-standard' assets being classified as `standard'; Wrong classification of an NPA: classifying a `loss' asset as a `doubtful' or `sub-standard' asset; classifying a `doubtful' asset as a `sub-standard' asset. Classifying an account of a credit customer as `substandard' and other accounts of the same credit customer as `standard', throwing prudential norms to the winds.

Essentially arising from the wrong classification of NPAs, there was a variation in the level of loan loss provisioning actually held by the bank and the level required to be made. This practice can be logically explained as a desperate attempt on the part of the bankers, whenever adequate current earnings were not available to meet provisioning obligations. Driven to desperation and impelled by the desire not to accept defeat, they have chosen to mislead and claim compliance with the provisioning norms, without actually providing. This only shows that the problem has swelled to graver dimensions. The international rating agency Standard & Poor (S & P) conveys the gloomiest picture, while estimating NPAs of the Indian banking sector
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between 35% to 70% of its total outstanding credit. Much of this, up to 35% of the total banking assets, as per the rating agency would be accounted as NPA if rescheduling and restructuring of loans to make them good assets in the book are not taken into account. However RBI has contested this dismal assessment. But the fact remains that the infection if left unchecked will eventually lead to what has been forecast by the rating agency
Table 5 NPA Statistics of the three Major Term Lending Institutions as at 31.03.2002. (Amount in Crores)
Name of FI IDBI ICICI IFCI Total Loans Total Loans NPA 31.3.2002 57099 52341 19841 31.3.2003 56477 57507 18715 31.3.2002 7665 3959 4103 NPA-% age NPA 31.3.2002 13.4 07.6 20.7 31.3.2003 8363 2782 3897 NPA-% age 31.3.2003 13.9 05.2 20.8

Financial institutions have not far lagged behind. NPAs of ten leading institutions have reported a rise of 11.89 per cent, or Rs 1,929 Crores, to Rs 18,146 Crores during the year ended March 2002 from Rs 16,217 Crores last year. The NPA statistics of the three leading Financial Institutions for the last two years are given in Table-5 IDBI tops the list by notching up bad loans worth Rs 7665 Crores by March 2002. In fact, its NPAs have gone up by Rs 1,185 Crores from Rs 6,490 Crores in the previous year. IFCI followed with NPAs of Rs 4,103 Crores, but it reported fall of Rs 134 Crores from the previous year's level of Rs 4,237 Crores. ICICI's NPAs went up to Rs 3,959 Crores from Rs 3,623 Crores in the previous year. Emergence of NPA as an Alarming Threat to Nationalized Banks:

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NPA is a brought forward legacy accumulated over the past three decades, when prudent norms of banking were forsaken basking by the halo of security provided by government ownership. It is not wrong to have pursued social goals, but this does not justify relegating banking goals and fiscal discipline to the background. But despite this extravagance the malaise remained invisible to the public eyes due to the practice of not following transparent accounting standards, but keeping the balance sheets opaque. This artificially conveyed picture of 'all is well' with PSBs suddenly came to an end when the lid was open with the introduction of the prudential norms of banking in the year 1992-93, bringing total transparency in disclosure norms and 'cleansing' the balance sheets of commercial banks for the first time in the country.

Adverse Effects of NPA on the Working of Commercial Banks: NPA has affected the profitability, liquidity and competitive functioning of PSBs and finally the psychology of the bankers in respect of their disposition towards credit delivery and credit expansion. Between 01.04.95 to 31.03.2003 Commercial banks incurred a total amount of Rs.31251 Crores towards provisioning NPA. This has brought Net NPA to Rs.32632 Crores or 6.2% of net advances. To this extent the problem is contained, but at what cost? This costly remedy is made at the sacrifice of building healthy reserves for future capital adequacy. The enormous provisioning of NPA together with the holding cost of such non-productive assets over the years has acted as a severe drain on the profitability of the PSBs. In turn PSBs are seen as poor performers and unable to approach the market for raising additional capital. Equity issues of nationalized banks that

63

have already tapped the market are now quoted at a discount in the secondary market. Other banks hesitate to approach the market to raise new issues. This has alternatively forced PSBs to borrow heavily from the debt market to build Tier II Capital to meet capital adequacy norms putting severe pressure on their profit margins, else they are to seek the bounty of the Central Government for repeated Recapitalization. Considering the minimum cost of holding NPAs at 7% p.a. (reckoning average cost of funds at 6% plus 1% service charge) the net NPA of Rs.32632 Crores absorbs a recurring holding cost of Rs.2300 Crores annually. Considering the average provisions made for the last 8 years, which works out to average of Rs.3300 crores from annum, a sizeable portion of the interest income is absorbed in servicing NPA. NPA is not merely non-remunerative. It is also cost absorbing and profit eroding. In the context of severe competition in the banking industry, the weak banks are at disadvantage for leveraging the rate of interest in the deregulated market and securing remunerative business growth. The options for these banks are lost. "The spread is the bread for the banks". This is the margin between the cost of resources employed and the return there from. In other words it is gap between the return on funds deployed (Interest earned on credit and investments) and cost of funds employed (Interest paid on deposits). When the interest rates were directed by RBI, as heretofore, there was no option for banks. But today in the deregulated market the banks decide their lending rates and borrowing rates. In the competitive money and capital Markets, inability to offer competitive market rates adds to the disadvantage of marketing and building new business.

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In the face of the deregulated banking industry, an ideal competitive working is reached, when the banks are able to earn adequate amount of non-interest income to cover their entire operating expenses i.e. a positive burden. In that event the spread factor i.e. the difference between the gross interest income and interest cost will constitute its operating profits. Theoretically even if the bank keeps 0% spread, it will still break even in terms of operating profit and not return an operating loss. The net profit is the amount of the operating profit minus the amount of provisions to be made including for taxation. On account of the burden of heavy NPA, many nationalized banks have little option and they are unable to lower lending rates competitively, as a wider spread is necessitated to cover cost of NPA in the face of lower income from off balance sheet business yielding noninterest income. Interest on Recapitalization Bonds is an income earned from the Government, who had issued the Recapitalization Bonds to the weak banks to sustain their capital adequacy under a bail out package. The statistics above show the other weaknesses of the nationalized banks in addition to the heavy burden they have to bear for servicing NPA by way of provisioning and holding cost as under: 1. Their operating expenses are higher due to surplus manpower employed. Wage costs to total assets are much higher to PSBs compared to new private banks or foreign banks. 2. Their earnings from sources other than interest income are meager. This is due to failure to develop off balance sheet business through innovative banking products

65

Effects of NPA on the Liquidity of the Nationalized Banks: Though nationalized banks (except Indian Bank) are able to meet norms of Capital Adequacy, as per RBI guidelines, the fact that their net NPA in the average is as much as 7% is a potential threat for them. RBI has indicated the ideal position as Zero percent Net NPA. Even granting 3% net NPA within limits of tolerance the nationalized banks are holding an uncomfortable burden at 7.1% as at March 2001. They have not been able to build additional capital needed for business expansion through internal generations or by tapping the equity market, but have resorted to II-Tier capital in the debt market or looking to recapitalization by Government of India.

IMPACT OF NPAS ON BANKS' PROFITS AND LENDING PROWESS: "The efficiency of a bank is not always reflected only by the size of its balance sheet but by the level of return on its assets. NPAs do not generate interest income for the banks, but at the same time banks are required to make provisions for such NPAs from their current profits.
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NPAs have a deleterious effect on the return on assets in several ways

They erode current profits through provisioning requirements They result in reduced interest income They require higher provisioning requirements affecting profits and accretion to capital funds and capacity to increase good quality risk assets in future, and They limit recycling of funds, set in asset-liability mismatches, etc There is at times a tendency among some of the banks to understate the level of NPAs in order to reduce the provisioning and boost up bottom lines. It would only postpone the In the context of crippling effect on a bank's operations in all spheres, asset quality has been placed as one of the most important parameters in the measurement of a bank's performance under the CAMELS supervisory rating system of RBI.

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PUBLIC SECTOR BANKS

Banks NPA to net advances (%) 2003 Allahabad Bank Andhra Bank Bank of Baroda Bank of India Bank of Maharashtra Canara Bank Central Bank Corporation Bank Dena Bank Indian Bank Indian Overseas Bank Oriental Bank Of Commerce Punjab & Sind Bank Punjab National Bank SB Of Bikaner & Jaipur SB Of Hyderabad SB Of Indore SB Of Mysore SB Of Patiala SB Of Saurashtra SB Of Travencore State Bank Of India Syndicate Bank UCO Bank Union Bank Of India United Bank Of India Vijaya Bank 7.08 1.79 3.72 5.37 4.82 3.59 6.74 1.65 11.83 6.15 5.23 1.4 10.89 3.86 4.13 3.25 2.66 5.19 1.49 3.53 3.06 4.5 4.29 4.36 4.91 5.52 2.61 2004 2.37 0.93 2.99 4.5 2.46 2.89 5.57 1.8 9.4 2.7 2.85 NIL 9.62 0.98 1.24 0.65 NIL 2.96 NIL NIL 1.39 3.48 2.58 3.65 2.87 3.75 0.91 68 Advances(crores) 2003 12,543.60 11,512.94 35,348.08 42,633.18 9,508.14 40,471.60 22,251.75 12,029.17 8,435.60 12,274.99 17,447.00 15,677.24 5,892.09 40,228.12 6,773.33 9,662.60 5,182.95 5,260.67 10,746.40 4,648.80 9,170.66 137,758.4 6 16,305.35 15,923.10 25,514.84 7,351.69 7,884.26 548,436.6 2 2004 15,341.54 12,885.47 35,600.88 45,855.90 11,731.51 47,638.63 22,804.11 13,889.72 9,411.79 14,126.08 20,294.86 19,680.76 6,030.01 47,224.72 8,596.55 11,813.68 6,406.06 6,306.72 13,086.34 5,540.48 11,132.43 157,933.54 20,646.92 20,626.44 29,425.91 7,963.34 11,045.31 632,739.69 Quadrant analysis 20 03 2004 LH LL HL HH LH HL HH LL LH LH LH LL LH HL LL LL LL LH LL LL LL HL LL LL HH LH LL LL LL HH HH LL HH LH LL LH LH LH LL LH HL LL LL LL LH LL LL LL HH LL LH HH LH LL

INFERENCE: Credit risk path of the PSBs: A Quadrant Analysis In the chart below an attempt is made to trace the relationship between NPA proportion and the size of credit portfolio (advances) of PSBs. For this purpose proportion of gross NPAs representing credit risk inherent is taken on the Y- axis and gross credit levels are taken on the X-axis. Since these two parameters are assets, which are stock concept variables, they have been plotted on the basis of 2 years 2003 and 2004 for a comparative analysis. QUADRANT TABLE- 2003.
NPA LEVEL CREDIT LEVEL LOW HIGH

LOW (BELOW AVG) (L)

LL (12) HL (4)

HIGH (ABOVE AVG) (H)

LH (8) HH (3)

QUADRANT TABLE- 2004

NPA LEVEL CREDIT LEVEL LOW HIGH

LOW (BELOW AVG) (L)

LL (13) HL (1)

HIGH (ABOVE AVG) (H)

LH (8) HH (5)

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As depicted in the tables, the banks are divided into 4 quadrants namely LL, LH, HL and HH (the figures are arrived at by taking the averages). The average of NPAs for the year 2003 is 4.6% and this figure is measured against each bank, any percentage above this figure falls in the H category and percentage below 4.6% falls in the L category. The same applies with the advances. The average of advances for 2003 is 20,312 crores and 23,435 crores for 2004. The average of NPA for 2004 is 2.7%. L represents low or below average of the PSBs and H represents high or above average. E.g. while LL means low in credit size and low in NPAs, LH implies low in credit size and high in NPAs. The following facts are visible from the quadrant table: 1).In the year 2003 the average of the NPAs was4.6%.25 banks had single digit (<10%) NPA levels. 2 banks were above 10% i.e. Dena Bank and Punjab and Sind Bank. The average of NPAs was 4.6%, out of which 20 banks were low or below average and 7 were high or above average. PSBs are mostly in the medium (10-20%) and higher risk (>20%) categories. However, for the purpose of simplicity only 2X2 matrix of risk levels is depicted. In the year 2004 the average of NPAs was 2.7%, all banks were below 10% and Dena Bank with a 9.4%. 14 banks remained in the low category and the remaining 13 banks were in the high category. 2).Among the nationalized banks most of he weak banks are in the LH quadrant. LH in the most undesirable quadrant one can find ones banks to be in. SB of Mysore was in this quadrant in 2003 and 2004. The weakest in this quadrant being Dena Bank (11.84% in 2003 and 9.4% in 2004 still in LH),
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Punjab and Sind Bank (10.89% in 2003 and 9.62% in 2004 still in LH), Allahabad Bank (7.08% in 2003 which turned to LL in 2004), Indian Bank (6.15% in 2003 and 2.7% in 2004 still in LH), Punjab National Bank (5.23% in 2003 and 2.85% in 2004 still in LH), United Bank of India (582% in 2003 and 3.75% in 2004 still in LH), SB of Mysore (5.19% in 2003 and 2.96% in 2004 still in LH) & Bank of Maharashtra (4.82% in 2003 moved to LL in 2004). 2 banks in the year 2004 moved to LH quadrant, Central Bank from HH moved to LH with 5.57% and UCO Bank moved from LL to LH with 3.65%. Punjab and Sind Bank and Allahabad Bank have wriggled out of this knot by making necessary provisions and readying themselves to tap capital markets for augmenting their capital adequacy ratio. 3).In 2003 there were 3 banks in the HH quadrant which increased to 5 in 2004. 4 banks which were in the HL quadrant in 2003, dropped to 1 in 2004.banks in the HH quadrant can move into HL quadrant with some strategic and determined efforts of recovery either on their own or through mergers.

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PRIVATE BANKS
NPA to net advances (%) 2003 Bank Of Punjab Bank Of Rajasthan Bharat Overseas Bank Catholic Syrian Bank Centurion Bank City Union Bank Development Credit Bank Dhanalakshmi Bank Federal Bank HDFC Bank ICICI Bank IDBI Bank Induslnd Bank ING Vysya Bank J&K Bank Karnataka Bank Karur Vysya Bank Kotak Mahindra Bank Lakshmi Vilas Bank Lord Krishna Bank Sangli Bank South Indian Bank Tamilnad Mercantile Bank United Western Bank UTI Bank 7.17 6.8 3.31 7.9 7.51 8.25 7.76 9.25 4.95 0.37 5.21 1.18 4.25 3.55 1.58 7.36 4.2 0.11 7.15 6.33 6.89 5.98 8.7 9.5 2.39 2004 4.69 2.99 2.26 4.65 4.43 6.37 4.87 6.68 2.89 0.16 2.25 0.25 2.75 2.6 1.48 4.98 2.32 0.17 5.4 6.05 6.56 4.55 5 8.95 1.29 Advances(crores) 2003 1,797.13 2,221.24 1,153.09 1,470.70 1,313.72 1,212.05 2,488.37 1,080.49 6,217.52 11,754.86 53,279.41 4,325.19 5,347.85 5,611.61 8,010.95 3,899.70 3,344.40 1,240.58 1,763.70 915.04 568.15 3,612.94 1,959.98 3,145.45 7,179.92 134,914.04 2004 2,353.46 2,431.63 1,391.52 1,898.24 1,556.41 1,546.98 2,439.52 1,138.59 7,700.53 17,744.51 62,095.52 7,398.92 7,812.23 7,046.51 9,284.94 4,667.92 4,023.24 2,097.02 2,038.70 1,117.90 648.25 4,196.82 2,113.99 3,744.47 9,362.95 167,850.77 Quadrant analysis 2003 LH LH LL LH LH LH LH LH HL HL HL LL LL HL HL LH LL LL LH LH LH LH LH LH HL 2004 LH LL LL LH LH LH LH LH HL HL HL HL HL HL HL LH LL LL LH LH LH LH LH LH HL

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INFERENCE: QUADRANT TABLE- 2003.

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NPA LEVEL CREDIT LEVEL LOW HIGH

LOW (BELOW AVG) (L)

LL (5) HL (6)

HIGH (ABOVE AVG) (H)

LH (14) HH (0)

QUADRANT TABLE- 2004

NPA LEVEL CREDIT LEVEL LOW HIGH

LOW (BELOW AVG) (L)

LL (4) HL (8)

HIGH (ABOVE AVG) (H)

LH (13) HH (0)

The NPA average for 2003 is 5.5 % and 3.8 % for 2004 The average of the advances for 2003 is 5,397 crores and 6,714 crores for 2004 1).As depicted in the tables, most of the private sector banks fall in the LH quadrant. In 2003 there were 14 banks which reduced to 13 in 2004. As seen in the quadrants, the credit size is low in the private sector banks and has a high NPA level compared to its credit size.

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2).There were 6 banks in the in the HL quadrant in 2003 which increased to 8 in 2004.3). Bank of Rajasthan moved from LH to LL maintaining the low level of advances and reducing their NPA levels from high to low. 4).IDBI Bank and Induslnd Bank moved from LL to HL increasing their advances and maintaining low levels of NPA. 5).the best performing bank in this sector was the ICICI Bank which was high in its credit size compared to the rest of the banks and still maintained a low NPA level.

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FOREIGN BANKS:
NPA to net advances (%) 2003 ABN Amro Abu Dhabi Commercial Bank American Express Bank Antwerp Diamond Bank N.V. Arab Bangladesh Bank Bank International Indonesia Bank Of America Bank Of Bahrain & Kuwait Bank Of Ceylon Bank Of Nova Scotia Bank Of Tokyo Barclays Bank BNP Paribas Calyon Bank Cho Hung Bank City Bank Credit Lyonnais DBS Deutsche Bank HSBC ING Bank JP Morgan Chase Bank Krung Thai Public Bank Co. Mashreq Bank Mizuho Corporate Bank Oman International Societe Generale Standard Chartered Bank Sumitomo Mitsui Banking Corporation UFJ Bank 1.54 9.68 8.69 NA 1.55 15.2 0.05 11.26 25.98 8.64 0.07 NIL 3.77 0.51 0.48 1.17 3.6 10.37 NIL 1.03 NIL NIL NIL NIL 0.76 42.15 NIL 0.31 20.21 8.58 2004 0.88 27.39 5.68 NA 0.37 72.15 NIL 17.73 21.85 9.07 0.1 NIL 2.7 1.01 0.8 1.4 2.6 NIL NIL 0.7 0.09 NIL NIL NIL NIL 61.37 1.37 0.52 12.78 NIL Advances(crores) 2003 5,443.98 273.7 1,190.09 175.96 17.36 18.31 3,298.14 352.76 84.58 1,459.77 438.86 2.30 1,422.71 232.07 75.25 12,628.69 658.02 191.74 1,607.64 8,202.14 34.26 0.00 11.67 41.32 187.63 27.89 86.81 13,041.79 311.64 173.47 51,690.5 5 2004 6,696.59 167.57 1,262.60 297.75 11.82 3.45 3,059.30 303.74 62.84 2,019.20 427.50 2.56 1,314.90 46.81 44.66 15,259.12 511.27 108.72 2,098.06 9,628.08 1.12 0.00 15.50 17.42 181.80 17.43 170.83 16,152.26 174.29 92.98 60,150.1 7 Quadrant analysis 2003 HL LH LH LL LL LH HL LH LH LH LL L L LL LL LL HL LL LH LL HL LL LL LL LL LL LH LL HL LH LH 2004 HL LH LL LL LL LH H L LH LH HH LL LL LL LL LL HL LL LL HL HL LL LL LL LL LL LH LL HL LH LL

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INFERENCE: QUADRANT TABLE- 2003.

NPA LEVEL CREDIT LEVEL LOW HIGH

LOW (BELOW AVG) (L)

LL (15) HL (5)

HIGH (ABOVE AVG) (H)

LH (10) HH (0)

QUADRANT TABLE- 2004

NPA LEVEL CREDIT LEVEL LOW HIGH

LOW (BELOW AVG) (L)

LL (17) HL (6)

HIGH (ABOVE AVG) (H)

LH (6) HH (1)

The NPA average for 2003 is 5.9% and 8% for 2004 The average of the advances for 2003 is 1,723 crores and 2,005 crores for 2004 1). Most of the banks in the foreign banks category fall into the LL quadrant. In 2003 there were 15 banks in this quadrant which increased to 17 in 2004. 2).The second highest is the LH quadrant which had 10 banks in 2003 which reduced to 6 in 2004.

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3).The effective quadrant being HL had 5 banks in it in 2003 which increased to 6 in 2004. 4).In 2003 there were no banks in the HH quadrant but in 2004 1 bank (Bank of Nova Scotia) moved unto this quadrant. HIGH CREDIT RISK PATH With the type of scatting visible in the charts, relation between the size of the credit portfolio and the proportion of NPA may not be a linear one. It is obvious that the relation is not non linear and will be significant if other relevant variables are also taken into account. Not withstanding the same, a smooth non linear hand curve has been drawn indicating the possible credit risk path of e banks which can be extrapolated to the banking system itself. The path indicates that for any bank which tries to expand its credit portfolio its NPA levels may cross and hover around the horizontal (credit risk avg) line. At the same time after it crosses the vertical (avg credit size) line, it may be sucked into the orbit of vicious spindle line around the horizontal line. In other words, external factors like the legal system and socio economic ad political factors for recovery do undergo change for the better; the credit risk path of the Indian banking system is likely to be high due to high gross NPA levels. No wonder the number of banks in the HL quadrant is low both in the private sector and foreign banks operating in India. It is also a warning for multinationals and other mega international banks and financial institutions which are aspiring to venture into the Indian banking system . To make it big they must realize that the can succeed and survive only when they are prepared to travel on the high credit risk path. It is also doubtful that big international banks will venture into India in a big
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way. They have bulldozed into consumer industries, given the above depicted high credit risk path of Indian banks. Such dilemma will come into place more so often when these mega MNC banks have opportunities in other countries to expand with lesser credit risk levels and without any threat of a high risk spindle spinning like a Damocles sword. Not withstanding the above, a multiple correlation and regression analysis, perhaps, will be more appropriate to throw further light in this context which is beyond the scope of the study. FACTORS DETEMING THE CREDIT RISK PATH. At any point of time the credit risk of a banks portfolio depends on two broad categories. The first is the banks internal set of factors like: size of the credit portfolio, proper data and information based credit policy, planning and budgeting systems, credit risk appraisal possessed at various levels of the organization, adequacy of monitoring and follow up systems and machinery in vogue, marketing and prompt service standards maintained etc., The other set of factors which are external are: the policy of the regulator and the government, growth of the economy, the efficiency of the legal system in enforcing the contracts, law and order situation, ethical standards of the society, other socio- political factor.

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FOREIGN BANKS:
NPA to net advances (%) 2003 ABN Amro Abu Dhabi Commercial Bank American Express Bank Antwerp Diamond Bank N.V. Arab Bangladesh Bank Bank International Indonesia Bank Of America Bank Of Bahrain & Kuwait Bank Of Ceylon Bank Of Nova Scotia Bank Of Tokyo Barclays Bank BNP Paribas Calyon Bank Cho Hung Bank City Bank Credit Lyonnais DBS Deutsche Bank HSBC ING Bank JP Morgan Chase Bank Krung Thai Public Bank Co. Mashreq Bank Mizuho Corporate Bank Oman International Societe Generale Standard Chartered Bank Sumitomo Mitsui Banking Corporation UFJ Bank 1.54 9.68 8.69 NA 1.55 15.2 0.05 11.26 25.98 8.64 0.07 NIL 3.77 0.51 0.48 1.17 3.6 10.37 NIL 1.03 NIL NIL NIL NIL 0.76 42.15 NIL 0.31 20.21 8.58 2004 0.88 27.39 5.68 NA 0.37 72.15 NIL 17.73 21.85 9.07 0.1 NIL 2.7 1.01 0.8 1.4 2.6 NIL NIL 0.7 0.09 NIL NIL NIL NIL 61.37 1.37 0.52 12.78 NIL Advances(crores) 2003 5,443.98 273.7 1,190.09 175.96 17.36 18.31 3,298.14 352.76 84.58 1,459.77 438.86 2.30 1,422.71 232.07 75.25 12,628.69 658.02 191.74 1,607.64 8,202.14 34.26 0.00 11.67 41.32 187.63 27.89 86.81 13,041.79 311.64 173.47 51,690.5 5 2004 6,696.59 167.57 1,262.60 297.75 11.82 3.45 3,059.30 303.74 62.84 2,019.20 427.50 2.56 1,314.90 46.81 44.66 15,259.12 511.27 108.72 2,098.06 9,628.08 1.12 0.00 15.50 17.42 181.80 17.43 170.83 16,152.26 174.29 92.98 60,150.1 7 Quadrant analysis 2003 HL LH LH LL LL LH HL LH LH LH LL L L LL LL LL HL LL LH LL HL LL LL LL LL LL LH LL HL LH LH 2004 HL LH LL LL LL LH H L LH LH HH LL LL LL LL LL HL LL LL HL HL LL LL LL LL LL LH LL HL LH LL

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INFERENCE: QUADRANT TABLE- 2003.

NPA LEVEL CREDIT LEVEL LOW HIGH

LOW (BELOW AVG) (L)

LL (15) HL (5)

HIGH (ABOVE AVG) (H)

LH (10) HH (0)

QUADRANT TABLE- 2004

NPA LEVEL CREDIT LEVEL LOW HIGH

LOW (BELOW AVG) (L)

LL (17) HL (6)

HIGH (ABOVE AVG) (H)

LH (6) HH (1)

The NPA average for 2003 is 5.9% and 8% for 2004 The average of the advances for 2003 is 1,723 crores and 2,005 crores for 2004 1). Most of the banks in the foreign banks category fall into the LL quadrant. In 2003 there were 15 banks in this quadrant which increased to 17 in 2004. 2).The second highest is the LH quadrant which had 10 banks in 2003 which reduced to 6 in 2004.

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3).The effective quadrant being HL had 5 banks in it in 2003 which increased to 6 in 2004. 4).In 2003 there were no banks in the HH quadrant but in 2004 1 bank (Bank of Nova Scotia) moved unto this quadrant. HIGH CREDIT RISK PATH With the type of scatting visible in the charts, relation between the size of the credit portfolio and the proportion of NPA may not be a linear one. It is obvious that the relation is not non linear and will be significant if other relevant variables are also taken into account. Not withstanding the same, a smooth non linear hand curve has been drawn indicating the possible credit risk path of e banks which can be extrapolated to the banking system itself. The path indicates that for any bank which tries to expand its credit portfolio its NPA levels may cross and hover around the horizontal (credit risk avg) line. At the same time after it crosses the vertical (avg credit size) line, it may be sucked into the orbit of vicious spindle line around the horizontal line. In other words, external factors like the legal system and socio economic ad political factors for recovery do undergo change for the better; the credit risk path of the Indian banking system is likely to be high due to high gross NPA levels. No wonder the number of banks in the HL quadrant is low both in the private sector and foreign banks operating in India. It is also a warning for multinationals and other mega international banks and financial institutions which are aspiring to venture into the Indian banking system . To make it big they must realize that the can succeed and survive only when they are prepared to travel on the high credit risk path. It is also doubtful that big international banks will venture into India in a big way.
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They have bulldozed into consumer industries, given the above depicted high credit risk path of Indian banks. Such dilemma will come into place more so often when these mega MNC banks have opportunities in other countries to expand with lesser credit risk levels and without any threat of a high risk spindle spinning like a Damocles sword. Not withstanding the above, a multiple correlation and regression analysis, perhaps, will be more appropriate to throw further light in this context which is beyond the scope of the study. FACTORS DETEMING THE CREDIT RISK PATH. At any point of time the credit risk of a banks portfolio depends on two broad categories. The first is the banks internal set of factors like: size of the credit portfolio, proper data and information based credit policy, planning and budgeting systems, credit risk appraisal possessed at various levels of the organization, adequacy of monitoring and follow up systems and machinery in vogue, marketing and prompt service standards maintained etc., The other set of factors which are external are: the policy of the regulator and the government, growth of the economy, the efficiency of the legal system in enforcing the contracts, law and order situation, ethical standards of the society, other socio- political factor.

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SUMMARYOF FINDINGS The brightest spot in the Indian banking industry in 2003-2004 was the massive cleaning up of banks balance sheets by reducing non performing assets (NPAs). The net NPAs of 82 banks- 27 public, 25 private and 30 foreign banks- studied, declined 25.8% or by a whooping Rs. 8,232 crore to Rs. 23,640 crore in 2004. Treasury income played a major role in reducing the net NPAs as banks liberally used treasury profit to clean up their books by making large doses of provisions. The NPAs of public sector banks declined by Rs. 6, 324 crore to Rs. 18,141 crore. Private Banks, with less red ink on their books, reduced their NPAs by Rs.1, 919 crore to Rs. 4,618 crore. Surprisingly, the NPAs f foreign banks rose by Rs. 13 crore to Rs. 882 crore during 2003-2004. Most banks were able to take advantage of fat profits from treasury operations, brought about by the lower interest rates, to make higher provisions for bad debts. As a result, 4 state owned banks- Oriental Bank of Commerce, State Bank of Indore, State Bank of Patiala And State Bank of Saurashtra- became zero NPA banks by the end of 2003-2004. 4 other public sector banks- Andhra Bank, Punjab National Bank, State Bank of Hyderabad and Vijaya Bank- were able to reduce their NPAs to below 1%. The rush to clean the balance sheets by making high provisions for NPAs had its impact on bottom lines. The 82 banks covered in the study, in percentage terms, had a lower net profit growth of 32.9 % (Rs. 23,035 crore) in 2003-2004 than the 53% (Rs. 17,331 crore) in 2000-2003. Private Banks were the hardest hit. In 2003-2004, the net profit of private banks grew by 32% to Rs. 4,254 crore versus a rise of 83.9 % (Rs.

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3,220 crore) in 2002-2003. The bottomlines of state owned banks grew 34.6 %( Rs. 16,546 crore) in 2004 versus 48% (Rs. 12,295 crore) in the previous year. Foreign banks clocked a 23% rise (Rs. 2,235 crore) in net profit s compared with 38 % (Rs.1, 816 crore) in 2002-2003. The lower growth in profit can also be attributed to the marginal rise in interest income. Interest income rose marginally by 2.5% to Rs.1, 43,437 crore in 2003-2004, compared with 12.5% (Rs 1, 39,931 crore) in 20022003. it is obvious that the fall in the cost of lending hit the growth in interest income. However, the net interest income of the banking industry rose sharply by 20%. In 2002-2003, the rise in net interest income was 21.3%. Banks indeed made huge treasury profits. However, the bread-andbutter lending business was not entirely neglected. The total advances of 82 banks rose 17.1% to Rs 8, 60,741 crore, up from a rise of 15.3% (Rs 7, 35,041 crore) in 2002-2003.

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SUGGESTIONS 1. Fixing up the budget for profits and recovery rather than for advances. Budget oriented approach at times leads to release of credit facilities without ensuring compliance of covenants of sanction. A suitable mechanism could be drawn at each bank level to provide monetary benefits/ re-organization of the operating staff particularly for recovery in NPAs write-off cases. 2. Projects with old technology should not be considered for finance. 3. Large exposure for big corporates/single project should be avoided. 4. There is a need for shift in PSBs approach from collateral security to viability of the project and intrinsic strength of the promoters. 5. Upgradation of credit skills of the operating staff working in advance. 6. Timely sanction/ release to avoid time and cost overruns. 7. It is suggested for possible restructuring of banks through mergers and acquisitions to keep themselves competitive in the high credit risk market in India. 8. Possibly one time solution like Asset Reconstruction Fund (ARF) may be relevant India. 9. Unless the magnitude f NPAs is brought down and ROA levels improved banks may not be able to infuse the confidence in the market in general and capital market in particular order to meet their capital adequacy needs.
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CONCLUSION An attempt is made in this study to present a comprehensive picture of non-performing advances of commercial banks in India, touching upon various quantitative and qualitative trends in the post reform period, besides carrying out with some policy and strategic implications. Undoubtedly India is one of the few countries where NPA levels are very high as there is an increase in the percentage of gross advances eroding their ROA by major basic points, after netting the provision. The net NPAs constitute a major percentage of the tangible net worth of the public sector banks, which represent a huge chunk of the banking system business. Not withstanding a lower proportion of NPAs. Private banks NPAs has shown a sudden spurt in the recent years making them vulnerable. The proportion of credit risk among the priority sector advances is double that of non-priority advances implying the irrationality of (administered) price controls, which still exists in some form. External factors outweigh the internal factor4s contributing to this high accumulation of NPAs. If the banks have to survive in the competitive and increasingly globalized market conditions they should be helped both by the RBI and the government in the form of faster recovery climate, especially for the legal processes of enforcement of contracts. Till such time the banks may be helped by recognizing their provisions against standard assets, additional provisions over and above the prudential norms, etc., as Tier II capital. The quadrant analysis of credit risk clearly identifies that all the big banks in India suffer from high NPA levels. It also offers scope for mergers and acquisitions among the banks to be better prepared for high risk credit
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marketing in India. Public sector banks suffer from a heavy NPA baggage. Hence, at one point of time, asset reconstruction fund pattern in a feasible shape may be helpful to the banks. Corporate defaults from their side will affect banks and they will not be in a position to lower the interest rates due to high default risk premier. The delivering point (i.e. the banks branch) structure is highly skewed with most attention paid to least risky non credit portfolio and very little or negligible attention towards the credit portfolio. Unless all efforts are made from within and without reducing the magnitude of NPAs, banks will not be in apposition to infuse requisite confidence in the capital market. Periodical visit to which is essential in future especially now when the government has almost said no to future capitalization of public sector banks.

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