A of any economy as it promotes stable

A strong banking system is the back bone of any
economy as it promotes stable and continues growth to take place. The banking
systems of different countries however, vary vastly from each other. India is
marked by its sizable population, wide geographical spread, diverse culture and
large income disparities. Owing to these characteristics, the Indian Banking
system is significantly different from other Asian countries. In India, the
banking system consists of commercial and cooperative banks. Nearly 2/3rds of
the house hold saving in the country are directed through the banking system.
The banks in India provide approximately 90% of the commercial credit
requirement of the country. Thus, in an economy dominated by the banking
sector, sustained impairment due to problems on the balance sheet leads to a
reduction in real economic activity and could culminate eventually into an
economic crisis.

The classification of assets on a bank’s balance
sheet is done under the following four heads:

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1.      
Standard Assets: This
type of asset is a performing asset. The asset generates continuous income for
the bank and culminates in repayments as and when they are due. They carry a
normal risk and are thus not treated as an NPA in the Indian banking industry.

2.     
Sub-Standard Assets :
These are all those loans as well as advances which are titled as
non-performing for a  12 month period in
the books of the bank.

3.     
Doubtful Assets: There
are those assets which are considered as non-performing for period of more than
12 months.

4.     
Loss Assets: Such asset
are ones which cannot be recovered. It is recognised as loss assets by either
the central bank or the auditors.

 Today, the
banking system faces a major concern of Non-Performing Assets. NPAs are
considered the primary indicator of credit risk and thus a good indicator for
the health of the banking sector. They are inevitable for any bank and thus the
success of a bank is often measured by their management of NPAs. In India, the
Public banks have shown better performance than the private banks in terms of
financial operations. However, simultaneously, they have been recording an
increase in NPAs. Increased NPAs are often an indicator or a weak credit
appraisal process. They also create the need of Provisions thus bringing down
the overall profitability of the banks.

There have been several legislations in India which
have impacted NPAs. The Financial Resolution and Deposit Insurance (FRDI) Bill
has been the newest attempt to attempt reducing the bad loans that the banks
are saddled with. While the government has made previous attempts in this
regard, they have only been moderately successful. A slew of legislations
including the Insolvency and Bankruptcy Code as well as the Securitization and
Reconstruction of Financial Assets and Enforcement of Security Interest Act, and
the Recovery of Debts due to Banks and Financial Institutions have been
instituted in the past. The government also attempted to set up Debt Recovery
Tribunals so as to fast-track proceedings. However the impact on improvement of
NPA has not been satisfactory. In fact over the last few years the magnitude of
the problem has only grown. It has not manifested itself into one of the
leading threats to the growth and stability on the Indian Economy. There is
thus a need to analyse the cause of the growing magnitude of NPAs in the Indian
banking sector and to find methods to control the same.

Due to the social banking motto of the Indian
banking system, the policy makers did not give it adequate attention until long
after the problem of bad loans found its roots. However, through the years,
with adoption of several reforms in the financial sector as well as the Indian
banking system ascribing to the international banking practices the issue of
NPAs received due focus. In India, the concept of NPA came into the ambit of
debate and policy making after the introduction of reforms in the financial
sector with the recommendations of the Report of the Committee on the Financial
System (Narasimham, 1991). Subsequently an appropriate accounting system was
put in place.

The definition of NPAs in India has changed
dramatically over time. According to the Narasimham Committee Report (1991),
those assets (advances, bills discounted, overdrafts, cash credit etc.) for
which the interest remains due for a period of four quarters (180 days) should
be considered as NPAs.1 Then, the above
defined  period was reduced. From March
1995 the assets for which the interest has remained unpaid for 90 days were
considered as NPAs.

 

 

Literature
Review

 

There is a substantial body of research that is present
on the subject which is present on the subject, a review of the relevant
content is done below:

Kumar (2013)
indicated NPAs to be one of the main challenges in performance of commercial
banks in the late 1990s in his study – A Comparative study of NPA of Old
Private Sector Banks and Foreign Banks. Another study conducted by Selvarajan
& Vadivalagan (2013) on Management of Non-Performing Assets in Priority
Sector talk about comparing Indian Bank to Public Sector Banks (PSBs. The study
finds that the growth of Indian Bank’s lending to Priority sector is more than
that of the Public Sector Banks as a whole. It indicated that Indian Bank has
not been able to control the NPAs in the early years of the decade thus leading
to accumulation of NPAs in the decade. Bloem & Gorter (2001) have suggested
an almost predictable level of NPAs, though they say that this may vary from
year to year. They note that NPAs are caused by an inevitably large number of
wrong economic decisions by individuals as well as plain bad luck which may
manifest itself in form of intemperate weather or sudden changes in the price of
some products. Chatterjee C., Mukherjee J. and Das (2012) in their study on
Management of non-performing assets – a current scenario has said that banks
must make an effort to find the original reasons of a loan required by the
borrower. Further the suggested that proper identification of the guarantor
must be undertaken by the bank including scrutiny of his/her wealth. These are
practices part of a strong credit appraisal process to which help create a
strong foundation of the loans given out thus reducing the risk of a bad debt
and subsequently the generation of NPAs. Further, Prasad G.V.B. and Veena
(2011) in their study on NPAs Reduction Strategies for Commercial Banks in
India said that NPAs have a dual impact on the assets that banks own and thus
the bank’s health. First banks have to forgo the interest that was otherwise
treated as income and second they are needed to provide provisions for NPAs,
thus reducing their current profits. Balasubramaniam C.S. (2001) addressed the
fact that the level of NPAs is substantial with all banks currently. The banks
must bring down their NPAs soon and this can be achieved by through
implementation of good credit appraisal procedures, as well as effective
internal control systems along with their efforts to improve asset quality in
their balance sheets.

 

Global Comparitive Analysis of
NPA’s

 

Source: Bank
nonperforming loans to total gross loans (%), World Bank

 

Table 2: Comparison
of NPA as percent of GDP, BRICS (World Bank)

Recovery Mechanism

The usual recovery
measures taken up by governments, like issuance of notices to enforce
securities and recovery of dues was deemed a process too time consuming by the
Indian Government. Thus, so as to improve the efficienciy of the process of
recovery of NPAs, the Indian government constituted a committee under the
chairmanship of late Shri Tiwari in 1981. The ask from the committee was the
examine the methods of recovering NPAs thus give recommended, including but not
limited to, the setting up of ‘Special Tribunals’ and thus expedite the
recovery process. These recommendations were later endorsed by the Narasimham
Committee (1991) which further suggested the setting up of Asset Reconstruction
Fund (ARF). The committee firther suggested that if necessary the Indian
Govenrment should establish this fund through a special legislation which
process a take-over of the NPAs from banks and financial institutions by the
government at a discount so as to the recover the dues owed by the primary
borrowers. On the basis of the recommendations made by the  Tiwari and the Narasimham Committees, the Debt
Recovery Tribunals were established across the country in different parts. There
was also the establishment of An Asset Reconstruction Company. Severa effort
were made to reduce NPAs. These included, inter alia, rescheduling and
restructuring of banks, restructuring of corporate debt. There was
establishment of Lok Adalats, Civil Courts, Debt Recovery Tribunals and
compromise settlement so as to enforce restructuring and recovery. Additionally,
introduction of legal reforms was hoped to speed up recovery.

1.      
SARFAESI Act

Up until the SARFAESI Act was put in place the legal
mechanism to recover default loans was far too cumbersome and time-consuming. It
was thus felt, that more power should be provided in the hands of the banks and
financial institutions to make it possible for them to sell securities to
recover dues. To achieve this end, the Indian Government appointed a committee
under the chairmanship of Shri T R Andhyarujina, senior Supreme Court advocate
and former Solicitor General of India, in 1999. Four reports were submitted by
the Committee. The first of them was related to securitisation. Based on the
recommendations of this, The Securitisation and Reconstruction of Financial
Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, was passed. This
act provides enforcement of the security factor without recourse to civil
suits. It was passed to empower banks and financial institutions to realise
long term assets, manage for themselves the problem of liquidity, try and reduce
asset liability mismatches and finally improve recovery by taking possession of
securities, selling them and reducing NPAs. The ordinance also made it possible
for banks and financial institutions to utilise the services of ARCs/SCs to speed
up the recovery of dues from defaulters and thus reduce their NPAs. The SARFAESI
act also contains provisions which make it possible for the ARCs/SCs to take direct
possession of the secured assets and/or of the management of the defaulting
borrower companies. They did not need to resort to the time-consuming process
of litigation and did not allow borrowers to take shelter under the provisions
of SICA/BIFR. In addition to passing the SARFAESI Act, certain other legal
reforms were also introduced to speed up the loan recovery process. 7 2. Other
Legal Reforms One of the important factors responsible for the ever-increasing
level of NPAs in the Indian banking industry is the weak legal system.
According to an international rating agency called FITCHIBCA, “The Indian legal
system is sympathetic towards the borrowers and works against the banks’
interest. Despite most of their loans being backed by security, banks are
unable to enforce their claims on the collateral when the loans turn
non-performing, and therefore, loan recoveries have been insignificant.”
However, efforts have been made to rectify these problems through the judicial
process as well as by enacting laws. In 1999, a standing committee under the
aegis of Industrial Development Bank of India (IDBI) was constituted to
initiate a co-ordinated approach to the recovery of large NPA accounts and for
institutionalising an arrangement between banks and financial institutions for
the systematic exchange of information in respect of large borrowers (including
defaulters and NPAs). Moreover, as mentioned above, in 2002 the SARFAESI Act
was passed and it empowered the creditors to foreclose non-performing loans and
the underlying collateral without going through a lengthy judicial or tribunal
process (Basu, 2005). All these efforts improved the recovery of NPAs by
commercial banks, which in turn has helped in reducing the NPA level. The total
worth of NPAs recovered through various channels was around Rs 4,039 crore
during 2003-04, which increased many fold to Rs 20,578 crore during 2004- 05.
Recovery of NPA Using the new institutions and legal options, banks and
financial institutions accelerated their recovery of NPAs. The NPAs recovered
by scheduled commercial banks through various channels is presented in Table 3
and Fig1. Between 2003-04 and 2005-06, the total cases referred to various institutions
was 93,2377 which was worth about Rs 70,226 crores. Out of this, around Rs
19,075 crore was recovered. In terms of cases, the highest number (5,53,042)
was referred to the Lok Adalats and the lowest (15,812) to the DRTs. In terms
of the amount involved, the DRTs recovered the highest amount of around Rs
32,745 crore and Lok Adalats the least, around Rs 2,965 crore. In terms of the
recovery, 58 per cent of the amount involved was recovered through one-time
settlement/compromise schemes. DRTs recovered around 29 per cent and Lok
Adalats recovered around 16 per cent, while 22 per cent of the amount was
recovered under the SARFAESI Act.

The intention of this dissertation is to study Non-Performing
assets in the context of the Indian Economy.

To achieve the same, it is imperative study the
economic history of the NPAs in India. This would involve studying the
alterations brought about by the M Narasimham committee in 1991 and the impact
of the same with respect to NPAs. The RBI’s policies are often impact by
international practices such as the Basel norms in banking. Interpretation of
NPAs and their management in the Indian context is subject to RBI policies.

Further to study the impact of policy decision on
NPAs in the both private and public sector banks. In the Indian context,
private and public sector banks have often taken different paths while
functioning in the same economy. This research intends to study the NPA trends
within public and private banks over time and conduct a comparative analysis between
the two.

Finally the study intends to research upon remedial
methods for banks to reduce the NPAs and further ways to improve the health of
the banking system in this regard. Also the study intends to research
preventive measures and practices that banks should take on to improve the
quality of assets on their balance sheets.

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