Bankers' Dilemma – To lend or ……… ?


Prof. Chowdari Prasad
Associate Professor
T A Pai Management Institute (TAPMI)
Manipal-576 104 (Karnataka)

Lenders have generally no perfect tools to find out profit-making and repaying borrowers from defaulters. Banks and Financial Institutions (including Non Banking Financial Companies) in India are facing problems of non-recovery.  Rough estimates indicate that more than 10 per cent of their lending is entangled in litigations amounting to over Rs. l,00,000 crores.  Studies were conducted by CII and FICCI, Banks themselves, Credit Rating Agencies, Trade Unions and others to ascertain the quantum of overdue amounts.

Reasons for Failure: Filing money suits is resorted to only after all other methods fail. This leads to strained relationship between the lender and borrower.  In last three decades, credit discipline was at the lowest in India for various reasons – partly from the bankers' side for want of systematic appraisal, sanction, documentation, timely disbursal and regular follow-up.  Failure from the borrowers' side could be on account of internal or external and for genuine or willful reasons.

Financial Sector Reforms and new initiatives: Thanks to the compelling and trying economic environment during the early 1990s, bureaucracy, politicians and the regulators realised and introduced "Reforms" in the Financial Sector. Balance Sheets of Banks and FIs were made transparent to all stake holders.  New Accounting policies (like Capital Adequacy, Income Recognition and Asset Classification, etc), guidelines for Asset Liability Management / Risk Management, enactment or amendment of related laws, Organisational changes, introduction of Information Technology, inviting of new private and foreign players, redefining concepts like Bad Debts (now called Non Performing Assets) and provisioning norms, changed Industrial Relations climate (including Voluntary Retirement Scheme), allowing  competition for determining of interest rates / launching of new products and services, setting up of bodies like Debt Recovery / Appellate Tribunals, appointment of Ombudsmen, revising branch licensing policy, application of techniques like Customer Relations Management, etc have brought in remarkable changes in the post reforms era.  Definition of NPAs (comprising Sub-Standard, Doubtful and Loss Assets) were clearly spelt out in 1993 and gradually revised from 360 days default to 90 days by April 2004.

MIS on NPAs: Recovery of loans is always an onerous task. Unscrupulous borrowers prefer to expand or diversify their businesses in preference to honoring their repayment obligations.  Fast changing economic conditions lead to frequent movement in the rates of interest.  If only the present level of computerization was not attained, it would have been a Herculean task for the bankers to handle the huge volume of accounts and render prompt customer service as well as recover the dues in time. 

Various alternatives for recovery: Besides civil procedure, there have been other methods open to banks – like (i) criminal action in respect of bouncing of cheques, (ii) remission of interest (iii) compromise settlements through One Time Settlement (OTS), (iv) Corporate Debt Restructuring (CDR), (v) implementation of BIFR awards,  (vi) filing of Winding Up petitions, vii) seizure and disposal of moveable assets, (viii) Lok Adalat system, etc.  With all such remedies available, there have been huge amounts of irrecoverable loans in the system, drawn into litigation for unduly long periods. There have been instances of some foreign banks resorting to appointing mercenaries to recover Car Loans, Consumer Loans or Credit Cards dues.  RBI was a silent spectator without any clear guidelines for such lending or recovery mechanism.

WTO, BIS and developments: Subsequently, several steps were initiated by Government of India or Reserve Bank of India.  Compliance to Bank for International Settlements (BIS) standards coupled with recommendations of Basel Committee for Bank Supervision (BCBS) has synchronized with the Narasimham Committee recommendations.  Similarly, entering into the Financial Services Agreement with World Trade Organisation (WTO) brought in notable changes in the fabric of Indian banking system.  With this backdrop, banking system in India is approaching to implement the Basel II norms with effect from March 2007.

Default in loan accounts or failure of banks is not peculiar to India only; it is a global phenomenon.  Narasimham Committee in its report in 1991-92 recommended for setting up of Asset Reconstruction Fund (ARF).  Bad Debts were to be taken out of the Banks' Balance Sheets by availing support from ARF. Such a Fund could be utilized to issue Bonds at Govt Securities at rates for duration of 5 years, guaranteed by GOI and reckoned for SLR and Capital Adequacy requirements.  However, this did not find favour with RBI or GOI.

International Experience: Globally, banks in various countries have experienced resolution of bad loans through similar mechanisms.  In countries like (a) Spain - Deposit Guarantee Fund (1977-80), (b)USA - Resolution Trust Corporation (1989), (c) Japan - Cooperative Credit Purchasing Company (1993), (d) Chile -  Cash Purchase of Bad Loans (1982), (e) Poland – Rescheduling of Bad Loans (1994), (f) Eastern Europe – Hungary – Government Bonds (1994), (g) Sweden – SECURUM (1993), (h) Philippines – Asset Privatisation Trust, (i) Malaysia – Soft Loans by Central Bank, (j) Ghana – NPA Recovery Trust (1989) and similarly Colombia, Czechoslovakia, Tanzania (1988) as well as Uganda (1995) such corrective steps were taken by respective governments.

The Agenda : The institutional framework for supervision and monitoring has also been strengthened, with particular focus on the problem of NPAs of the banking system.  Earlier, the Tarapore Committee on Capital Account Convertibility had recommended a reduction in NPAs from 13.7 per cent to 5 per cent in 3 years, along with improved risk management by the banks and development of an effective supervision system.  Although this target has not yet been met, several important legal and regulatory measures have been undertaken to tackle the problem of NPAs.  One such early key measures was instituting of DRTs under a separate act However, much progress could not be achieved through this mechanism too.

Proposal for ARCs: Mr Narasimham in 1997-1998 again recommended setting up of Asset Reconstruction Companies (ARCs) in place of earlier ARF (1991).  These Companies were to be floated with capital from Banks and FIs, in private sector like Special Purpose Vehicles (SPVs); experienced staff members to be deployed from Banks and FIs,   to issue Bonds in lieu of Financial Assets taken over and guaranteed by GOI; with exemption from Stamp Duty and treated as on par with Venture Capital Funds for Income Tax purposes.

It took another four years for issuing an Ordinance in June 2002 and enacting in December 2002 as Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act,(SARFAESI Act) 2002.  Instead of providing for only Asset Reconstruction work, a new financial services product called Securitisation was formalized although such transactions were being carried out by ICICI, NHB and others in early 1990s itself. The Act affords powers to lenders to (i) seize the assets (ii) change the management and (iii) securitise the Financial Assets.

RBI, in its guidelines defined an ARC as a Company which is set up with the objective of taking over distressed assets (Non Performing Assets) from banks or financial institutions and to reconstruct or re-pack these assets to make those assets saleable.

The legal hurdles: Unfortunately, some provisions of the Act were challenged in Supreme Court by one of the big defaulters - M/s Mardia Chemicals against ICICI Bank exercising its powers newly vested.  RBI issued Guidelines to Banks and FIs in 2003 about sale of Financial Assets to SPVs and setting up of (i) Asset Reconstruction Companies and (ii) Securitisation Companies.  The objectives of ARCs comprise (a) To buy out troubled loans from banks and make special efforts at recovering value from the assets, if necessary by special legislation, with special powers for recovery and (b) Restructuring the weak banks to divest the bad loan portfolio – essential for a comprehensive restructuring strategy of weak banks.

The Supreme Court in April, 2004 in M/s Mardia Chemicals case, upheld the constitutional validity of SARFAESI Act and its provisions except that a subsection 2 of Section 17 by the secured creditor, in case the borrower wants to appeal against the secured creditor's notice under Section 13 (4)  of the Act.  It declared Section 17 (2) as unconstitutional and violative of Article 14 of the Constitution of India.  In the wake of this judgement, many banks have pointed out practical difficulties likely to arise in speeding up the recovery of NPAs.  The suggestions in this regard were examined to carry out necessary amendments in the Act.  In the Union Budget 2004 – 05, the Government proposed the amendments to relevant provisions of the Act to appropriately address the Supreme Court's concerns regarding a fair deal to borrowers while, at the same time, ensuring that the recovery is not delayed or hampered.

The Progress in containing NPAs: The following table gives a comparative picture of progress recorded by different types of banks in India in reducing the percentage of Gross and Net NPAs to the Total Assets for a period of four years between 2000 and 2004.  This achievement is appreciable and could be attributed to the concerted efforts made by the banks and the impact of SARFAESI Act, 2002.  Here we can see the significant changes in the position among all types of banks including Foreign Banks in India.

Non Performing Assets of Public, Private (Old and New) Sector and Foreign Banks

Gross NPAs / Total Assets          


(in Per Cent)

Net NPAs / Total Assets





S No.

Types of Banks










Nationalised Bks (19)










State Bank Group (8)










Public Sector Banks










Old Private Banks (20)










New Private  Bks (10)










Total Private Banks










Foreign Banks (33)





Source : RBI Report on Trend and Progress in Banking, 2003-04 

As many as six ARCs were being set up by different agencies in India in recent years – the first being Asset Reconstruction Company India Ltd (ARCIL) as a collaborative effort of (i) State Bank of India, (ii) HDFC (iii) IDBI  and (iv) ICICI Bank.  It is reported that ARCIL has presently an equity capital of Rs 104 crores, held by seventeen banks in India, handles over ten per cent of the NPAs. 

Proposed ARCs: Other Reconstruction Companies in the process are (1)Asset Care Enterprise (ACE) – jointly floated by IFCI and Punjab National Bank  (2) ASREC by Andhra Bank, Stanchart Bank, Deutsche Bank and UTI  (3) ARC proposed by IndusInd Bank (4) ARC to be floated by Kotak Mahindra Bank and (5) another awaiting approval from FIPB - by ACTIS (formerly CDC Capital Partners) with 48% capital; Corporation Bank (26%) and ING Vysya Bank Ltd (26%) with an aggregate proposed capital of     US$ 100 – 150 millions.

The ongoing dilemma: Banking system in India has been growing healthier and stronger year after year.  As on August 20, 2005 the RBI Weekly Statistics show that the aggregate deposits are to the tune of Rs 18,38,419 crores while the Investments and Bank Credit are of the order of   Rs. 7,67,096 and Rs. 11,85,456 crores respectively.  There has been steady increase in alround business of all Banks and Financial Institutions despite several constraints including stiff competition and problems of stagnated bad loans.  The real dilemma for a banker is that having accepted sizeable deposits, should they be deployed in investment portfolio beyond the SLR stipulations or lend profitably and follow up for recovery.

Prof. Chowdari Prasad
Associate Professor
T A Pai Management Institute (TAPMI)
Manipal-576 104 (Karnataka)

Source: E-mail September 9, 2005


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