Concept of NPA and its position after Economic Liberalization


By

Dr. K. Murugadoss
Asst. Professor and Head
Department of Commerce
Periyar Govt. Arts College
Cuddalore–607001

Dr. P. Murugan
Asst. Professor
Department of Commerce
Govt. Arts College
Chengalpet, Chennai
 


The post economic-liberalization era of India witnessed a phenomenal growth in the operations of commercial banks, particularly in the operations for the benefit of the higher to neglected sectors namely the priority sector. At the same time, some of the sub-sectors under the priority sector still remained either unnoticed or neglected. These sub-sectors got only a negligible share of the total credit under priority sector lending by commercial banks.

Concept of NPA:

In India, the banking system has very long history evolving over many years passing through different phases after independence.  After financial sector reforms as part of economic liberalization, the Indian banking system has undergone many noteworthy transformations.  One such transformation has been the adoption of best international practices in regulating and supervising the money market of the country.   In order to create a strong competitive and vibrant banking system, the country has allowed entry of new private sector banks and foreign banks leading to flexibility in operational work and financial autonomy to public sector banks in respect of fund mobilization and credit management.  The banking sector has to concentrate on the effective management of funds, to avoid the hindrance of rotation of funds.  Because many studies highlighted that most of the beneficiaries have used the loan amount for the purposes other than actual diverted the loan amount have used it for social ceremonies prior to spending on house maintenance and repaying old debts.  This may be one of the causes for accumulation of overdue balances. This will leads to poor recovery performance and will affect the banking regular activity.  So, the concept of Non Performing Assets (NPA) is developed, to help the financial institutions to speed up the collection and to make special effort to recover with the help of various Laws in force.

Need of post disbursement period supervision:

Further, the priority sector lending by the public and private sector commercial banks are constrained by few inadequacies such as misuse of funds by some borrowers under the scheme and misdirection or diversion of funds to unproductive directions that has been indicated by few earlier studies. Moreover, there are the problems of inadequacies on the part of commercial banks in the administration of priority sector advances and some commercial banks under both public and private sectors have been faulted in the identification of right type of customers as beneficiaries under the priority sector lending.   Also, the banks' quality of supervision in the post disbursement period is poor leading to accumulation of overdues which in turn has increased the level of Non-performing Assets (NPAs).

To recover default loans, the banks have adopted three different measures, viz., seizure of property, legal action and sending reminders to the borrowers.  Out of three measures, sending reminders is the commonly and most often adopted measure followed by legal action and seizure of property by banks.  Facing with property seizure and legal action of the banks is less for female beneficiaries than that of male beneficiaries in the study area whereas encountering with these two measures is more among married group.  Between public and private sector banks, extent of adopting recovery measures such as seizure of property and sending reminders are significantly more in private sector banks than public sector banks.

What is Non-Performing Assets:

The concept of NPAs is based on loans and advances.  Loans and advances are treated as performing assets if they generate income regularly whereas they are treated as "non-performing assets" when they cease to generate income (Here income means interest, fees and commission etc. to the bank) which result in losses of income to the banks (financial institutions). In other words, a loan asset becomes NPA when it is not recovered in the stipulated time and not generating any income.

NPA is a term in accounting system of banks / financial institutions for classifying the loans that are in risk of default.  Banking businesses involves borrowing money from the public in the form deposits and lending them to the needy persons and business at a premium. Lending money involve a credit risk because the loans and advances made by banks or financial institutions are likely to turnout as non - productive, non-rewarding and non - remunerative which are likely to become NPA.

Factors Responsible for accumulation of NPAs:

There are so many factors responsible for the accumulation of NPAs in Banking sector in general, of which some of them plays important role like,

* Diversification of funds for purposes other than actual. That is, obtaining funds for new projects but diversifying the fund associate concerns. This is coupled with recessionary trends and failure to tap required funds in the capital and debt market.

* Business failure due to failure in product / marketing as well as due to failure in financial management, strained labour relations, adoption of inappropriate technology, using outdated and outmoded machinery, technical problems and product obsolescence.

* Economic recession, input shortage, power shortage, price escalation, accidents, natural calamities and problems with customers or in other countries leading to non – payment of over dues.

* Over run cost and time during project implementation stage.

* Frequent change in Government policies like changes in pollution control norms, excise duties, poor credit decisions, priority sector lending and legal systems.

* Willful default, siphoning off funds, fraud and misappropriation of loan funds by promoters and dispute among directors.

* Delay in release of funds by banks and delay in release of subsidies by government.

* Delay in finalizing the rehabilitation package by the BIFR (Board of Industrial and Financial Reconstruction)

* Absence of written policies.

* Lack of portfolio concentration limits, proper industrial and financial analysis of borrowers.

* Excessive reliance on collateral, absence of proper follow up action by banks as well as poor control on loan documentation.

* Absence of asset classification and loan loss provisioning standards and

* The lack of co-ordination between commercial banks and financial institutions meant for industrial development, which provide long-term needs of industry, which lead to misuse of the funds by the industries.

Loan is considered to be a default loan in turn leading or lending to non-performing asset if the borrower has failed to pay interest on principal amount or delayed paying installment of principal amount for 90 days. Non-performing assets are problematic for financial institutions since they depend on interest payments for income. Sometimes, troublesome pressure from the economy can lead to a sharp increase in non-performing loans and often results in massive write-downs.

Problem of NPAs

Technically, NPAs are loan accounts of borrowers, which have been classified by a bank into three categories viz, standard asset, sub-standard asset and Loss assets in accordance with the guidelines relating to asset classification issued by the RBI (Reserve Bank of India). The build-up of NPAs is an important factor in banking sector determining its financial stability and growth as high NPAs have a deteriorating impact on capital, liquidity and profitability of the banking institutions.  Moreover, a high level of NPAs hampers the bank ability to recycle funds and puts a strain on the net worth of banks. Since the onset of the global financial crisis, the Indian banking system has become a source of concern due to rising NPAs.

The borrowers are mainly farmers and small scale industry owners whose financial conditions are generally weak. The volume of bank credit tacked in sick industries is the evidence of this malady. Sometimes, based on the advice given by Board for Industrial and Financial Reconstruction (BIFR) as well as based on the directions given by the courts to banks, the banks are forced to provide loans to sick industries. This type of practice has aggravated NPAs situation in banks, another, faulty lending policy and making compulsion lending to priority sector by banks. There are many other causes which are also responsible for accumulation of NPAs.

Many of these causes are related to faulty credit management like defective credit in recovery mechanism, lack of professionalism in the work force, time lag between sanctions and disbursement of loan, unscientific repayment schedule, mis-utilization of loans by user, untimely communication to the borrowers regarding their due date, lack of sponge legal mechanism, political at local levels and waive-off policy of loan by government (in 1991 & 2008) have also been contributing to mounting NPAs in Scheduled Commercial Banks (SCBs) in India1.

In the fast changing world and in turn fast changing banking environment of today, the very survival of a banking institutions depends on extent of income generated by optimum use of funds / assets (capital and deposits) after paying for the cost of deposits acquired from the customers and other administrative costs involved. Once the funds / assets cease to contribute the income, they are termed as Non Performing Assets.  One of the major problems being faced by banking and financial institutions in India is bad debts, termed as "Non Performing Assets" (NPA). Many factors contribute to the problem of NPA in banking and financial institutions.  The major factors among them are: 1) Political interference, 2) Poor law enforcement, 3) Archaic laws and procedures, 4) Corruptions at various levels and 5) competition in various banking institutions. Taking the importance of such strategic affairs of Indian banking industry into consideration, it is felt necessary to carry out a paper like this on NPA in banks in India.

Status of NPAs after Economic Liberalization

The introduction of prudential norms relating to NPAs helped Indian banks to witness a steady improvement in the asset quality during post-economic liberalization
period. This is evident from the declining trend in share of gross and net NPAs to gross advances between 2000-04 and 2012-13 as exhibited in Table 1.

According to the table, the gross NPA to gross advances of SCBs (Scheduled Commercial Banks), placed at 11.4 per cent in 2001-01, had declined to 3.2 per cent in 2012-13, in turn indicating an improvement in the credit appraisal process adopted by SCBs as well as implementation of new legal initiatives coupled with greater provisions and write-offs. During the crisis year of 2008-09 the gross NPA to gross advances of SCBs had been almost same compared to the previous year (2.4% against 2.3% in the previous year). Thus, the Indian banking sector was initially insulated from the global financial crisis.

Conclusion:

The accumulation of NPAs is found to have been affecting the profitability, increase in standard assets, employment generation, income levels of the bank employees and capital adequacy levels. 

Both the Central government and RBI have together taken various steps for controlling incidence of fresh NPAs and created legal and regulatory environment to facilitate the recovery of existing NPAs in banks.

Table 1

Gross and Net NPA to Gross Advances in Indian Banks

Year

Gross NPAs as %of Gross Advances

Net NPAs as %of Gross Advances

Public Sector Banks

Private Sector Banks

Foreign Banks

SCBs

2000-01

12.4

8.4

6.8

11.4

6.2

2001-02

11.1

9.6

5.4

10.4

5.5

2002-03

9.4

8.1

5.2

8.8

4.4

2003-04

7.8

5.9

4.6

7.2

2.9

2004-05

5.5

3.8

2.9

5.1

2.0

2005-06

3.6

2.6

1.9

3.3

1.2

2006-07

2.7

2.4

1.8

2.5

1.0

2007-08

2.2

2.8

1.8

2.3

1.0

2008-09

2.0

3.3

4.3

2.4

1.1

2009-10

2.3

3.0

4.3

2.5

1.1

2010-11

2.4

2.5

2.5

2.5

1.1

2011-12

3.3

2.1

2.6

3.1

1.4

2012-13

3.6

1.8

3.0

3.2

1.6


SCBs – Scheduled Commercial Banks

Source: Reserve Bank of India, "The Banking Sector in India: Emerging Issues and Challenges", Report on Currency and Finance, Vol.I.

The deteriorating asset quality of the banks in India emerged as a major concern, with the gross NPAs registering a sharp increase, especially of public sector banks (PSBs) in the recent past.

One time settlement scheme has been implemented by the Government of India to deal with NPAs through Debt Recovery Tribunals (DRTs) established in 1993 under Parliament Act 51 by Government of India and also through Lok Adalat.

It is however concluded that NPA has unique marginal role in determining the financial performance banks in general. This had led to the final conclusion that NPA is not ignorable one and it needs the attention of bank management because of its marginal role in affecting the banks' financial performance in India.

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1Mohan Kumar and Govind Singh. (2012). "Mounting NPAs in Indian Commercial Banks",
International Journal of Transformations in Business Management, Vol.1, Issue 6, Apr-Jun, pp.118-137.
 


Dr. K. Murugadoss
Asst. Professor and Head
Department of Commerce
Periyar Govt. Arts College
Cuddalore–607001

Dr. P. Murugan
Asst. Professor
Department of Commerce
Govt. Arts College
Chengalpet, Chennai
 

Source: E-mail September 28, 2015

          

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