NPA Stifles Banking in India

The banking sector is plagued with non performing assets (NPA). Anirban takes a look into the evil that affect banks.

The Indian banking system has gone through significant changes following the financial sector reforms. However, certain changes in the banking system mandate the banks to improve overall efficiency, by bringing down the non performing assets (NPAs), and improve profitability, and overall health of the banks.

Going by the current rules, a non-performing asset or an NPA is a loan or advance, where:

  1. Interest and /or installment of principal remain overdue for a period of more than 90 days
  2. The account remains ‘out of order’ for a period of more than 90 days, in respect of an overdraft/cash credit (OD/CC)
  3. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted
  4. Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, and
  5. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

Impact of NPA on Operations

NPA means booking of money in terms of bad asset, which occurred due to wrong choice of client. Because of the money getting blocked the prodigality of bank decreases not only by the amount of NPA but NPA lead to opportunity cost also as that much of profit invested in some return earning project/asset. So NPA does not affect current profit but also future stream of profit, which may lead to loss of some long-term beneficial opportunity. Another impact of reduction in profitability is low return on investment (RoI), which adversely affect current earning of bank. Liquidity money gets blocked, decreased profit lead to lack of enough cash at hand, which lead to borrowing money for shortest period of time. All these translate into additional cost.

Difficulty in operating the functions of bank is another cause of NPA due to lack of money. Involvement of management time and efforts of management is another indirect cost, which bank has to bear due to NPA. Time and efforts of management in handling and managing NPA would have diverted to some fruitful activities, which would have given good returns. Now days, banks have special employees to deal and handle NPAs, which is additional cost to the bank. If a bank is facing problem of NPA, then it adversely affects the value of bank in terms of market for credit. It loses its goodwill and brand image and credit which have negative impact to the people who are putting in their money in the banks.


NPA Norms

Though the issue of NPA was given more importance after some time, it highlighted its impact on the financial health of the commercial banks and, subsequently, various asset classification norms were introduced. A critical analysis to monitor credit comprehensively and uniformly was introduced by the RBI by way of the Health Code System (HCS) in the banks. This system provided information regarding the health of individual advances, the quality of the credit portfolio and the extent of advances causing concern in relation to total advances. It was considered that such information would be of immense use to banks for control purposes. The RBI advised all commercial banks (excluding foreign banks, most of which had similar coding system), to introduce the HCS, indicating the quality (or health) of individual advances under the following eight categories, with a health code assigned to each account that has borrowed:

  1.  Satisfactory: Conduct is satisfactory; all terms and conditions are complied with; all accounts are in order and safety of the advance is not in doubt.
  2. Irregular: The safety of the advance is not suspected, though there may be occasional irregularities, which may be considered as a short term phenomenon.
  3. Sick, viable: Advances to units that are sick but viable – under nursing and units for which nursing/revival programs are taken up.
  4. Sick: non-viable/sticky: The irregularities continue to persist and there are no immediate prospects of regularisation and the accounts could throw up some of the usual signs of incipient sickness
  5. Advances recalled: Accounts where the repayment is highly doubtful and nursing is not considered worthwhile and where decision has been taken to recall the advance
  6. Suit filed accounts: Accounts where legal action or recovery proceedings have been initiated
  7. Decreed debts: Where decrees (verdict) have been obtained.
  8. Bad and doubtful debts: Where the recovery of the bank’s dues has become doubtful on account of short-fall in value of security, difficulty in enforcing and realizing the securities or inability/unwillingness of the borrowers to repay the bank’s dues partly or wholly

Under the above HCS, the RBI classified problem loans of each bank into three categories: (i) advances classified as bad and doubtful by the bank (Health Code No.8) (ii) advances where suits were filed/decrees obtained (Health Codes No.6 and 7) and (iii) those advances with major undesirable features (Health Codes No.4 and 5).


Asset Classification

Assets are classified into following four categories:

  1. Standard Assets
  2. Sub standard Assets
  3. Doubtful Assets
  4. Loss Assets

Standard Assets: These are the ones in which the bank is receiving interest as well as the principal amount of the loan regularly from the customer. Here, it is also very important that in this case the arrears of interest and the principal amount of loan do not exceed 90 days at the end of financial year. If asset fails to be in category of standard asset that is amount due more than 90 days then it is NPA, and NPAs are further need to classify in sub categories.

Provisioning Norms: The banks have to make a general provision of a minimum of 5 per cent on standard assets on global loan portfolio basis. The provisions on standard assets should not be reckoned for arriving at net NPAs. The provisions towards Standard Assets need not be netted from gross advances but shown separately as ‘Contingent Provisions against Standard Assets’ under ‘Other Liabilities and Provisions’ in Schedule 5 of the balance sheet.

Sub Standard Assets: A substandard asset would be one, which has remained NPA for a period less than or equal to 12 month. The following features are exhibited by substandard assets: the current net worth of the borrowers/guarantor or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full; and the asset has well-defined credit weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

Provisioning Norms: A general provision of 10 percent on total outstanding should be made without making any allowance for DICGC/ECGC guarantee cover and securities available.

Doubtful Assets: A loan classified as doubtful has all the weaknesses inherent in assets that were classified as sub-standard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values – highly questionable and improbable. An asset would be classified as doubtful if it remained in the sub-standard category for 12 months.

Provisioning Norms: It is important to bear in mind that entire assets cannot be written off. If the assets are permitted to remain in the books for any reason, provision must be done with proper calibrations. Provisioning must be at least 40 per cent.

Loss Assets: A loss asset is one which considered non-collectable and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value. Also, these assets would have been identified as ‘loss assets’ by the bank or internal or external auditors or the RBI inspection but the amount would not have been written-off wholly.

Provisioning Norms: The entire asset should be written off. If the assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for.

Measures to Control NPAs

In the present scenario NPAs are at the core of financial problem of the banks. Concrete efforts have to be made to improve recovery performance. Measures required to be undertaken are mainly two fold. Banks should make efforts first to avoid fresh addition on NPAs by their effective presentation appraisal and secondly to recover the amount from accounts, which have already turned bad.

 Preventive Measures: Most of the bankers feel that genuine viability problem of the borrowing units, weakness in credit appraisal system, absence of effective monitoring and supervision of loan account, absence of credit information sharing among the banks etc. are some of the significant causative factors of high level of NPAs internal to the banks.

  • So for preventive the fresh inflow of funds into the non-performing category, banks should reformulate their credit appraisal techniques.
  • Proper evaluation of the loan application may help in detecting the non-viable projects at the first instance.
  • Full information about unit, industry, its financial stake, management etc. should be collected. Industrial cell should be established at the bank level, which would have complete information about the industry and its prospects in future.
  • Proper credit monitoring should be equally emphasised. There should be proper flow of information from the units regarding their financial area, annual accounts, stock reports etc., which would enable the banker to know the need based credit requirement of borrower and warning signals for taking quick remedial action.
  • Banks should inspect the progress of the project or the business. Separate monitoring department should be established in large branches for periodical review of accounts, comparative risk analysis and compliance of terms and conditions of sanction. Equal emphasis should be given for monitoring of standard assets also.
  • Banks should be equipped with latest credit risk management techniques to protect the bank funds and minimise insolvency risks. Banks should develop credit derivatives markets to avoid these risks. There should be regular outflow of senior bank officers from all public sector banks for specialized training in training institute to equip them with latest procedures and practices.

Curative Measures: Besides making efforts to stop the fresh additions of NPAs banks have to take steps to recover the amount from assets, which have already slipped into NPAs category. Significant causative factors highlighted were slow recovery of legal cases, willful default induced by officially announced loan waiver schemes etc. 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.
  • A committee on financial system has recommended the establishment of Debt Recovery Tribunals (DRT) for the speedy recovery of the assets from NPAs category. On the basis of recommendations 22 DRTs were established by passing the bill on Recovery of Debt due to Banks and Financial Institutions Act. But the performance of DTRs for the past years has not been found satisfactory or up to the mark.
  • The Act has some limitations, which must be removed to make its effective implementation.  At present one presiding officer is handling at least 80-90 cases, per day. It is suggested that DRT Act may be amended to enable the central government to appoint additional presiding officers for speedy disposal of recovery cases.
  • One of the major factors accounting for delay in disposing of application by DRT is the delay caused due to refusal by defendants to accept the summons, and at times due to change in address too.
  • DRT may be empowered to order service of summons by hand, registered post and by publications simultaneously. Attachment of immovable property of borrower is not admitted due to service of summons.
  • Enforcement of security and obtaining court decree take unduly long time, it encourages willful default and ultimately the banks may be compelled to write off loans. Willful default should be declared a criminal offense.
  • Government should not go for mass waiver of interest/ installments as it sends unhealthy signals to the borrower. During 1990-91 there was a massive waiver of rural debt amounting to over Rs. 15,000 crore and Rs. 65,000 crore, in 2008. These types of activities put a premium on willful default and dishonesty. It lowers the repayment ethics.
  • In case of government sponsored schemes government should assist in recovery. It may be noted that suggestions enumerated will go a long way in reducing the NPAs. This will only considerably improve the profitability of the banks, improve the quality of assets, but also make the Indian banking system stringent, resilient and geared to meet the challenges of globalization.

Suggestions and Remedies for Management of NPAs:

  • Banks must publish the names of those who are becoming NPAs, and in particular those cases where write-off is done.
  • Focused on auditing should be done separately for NPAs.
  • The foremost important point is, when written-off account holders should not eligible for any banks in future and data maintain by banking association. It should be available for all banks when they required.
  • RBI must take the restructuring loan classification mechanism. This would enable to critically evaluate the implication of the measure.
  • Whatever the banks carry higher NPA, to publish their plan to reduce NPAs along with their annul accounts and periodical monitoring mechanism should play a key role for reducing NPA.
  • Concern MSMEs, these two segments are impacted more on NPAs, for going forward; they have to streamline the mechanism.
  • RBI should setup an independent general body to make a decision on NPAs.
  • Banks are compromising when counter party re-payments. Here, RBI and government will take up the issue seriously.
  • When sincerely resolving large NPA accounts then bank does not require maintaining provision. One side bank net worth gets increase and do more services to public.
  • Identify the weaker accounts, which need to work for account to account, for bring down NPA. One time settlements schemes are effectively speed up recovery of small loans.
  • DRTs have not able to much impacted on loan recovery since, in adequate numbers, lack of infrastructure. It is essential that DRTs mechanism should be strengthened.
  • Information sharing arrangement is now possible through the newly formed Credit Information Bureaus. This will prevent those who take advantage of lack of system of information sharing among lending institutions to borrow large amount against same assets and property.


On the basis of the discussions above, certain broad observations, issues and perspectives on the performance of banking sector and financial stability of the economy on the eve of the introduction of Basel III norms by RBI to the banks would be appropriate:

  1. In retrospect, the Indian banks have overall demonstrated a trend of continued good performance and profitability despite rising interest rates, increase in operating costs and the spillover effects of recent global financial crisis .This is reflected in higher credit growth deposit record, better return on assets, and return on equities. (ROE) The capital position improved significantly as the banks were able to mobilize substantial funds.
  2. As observed from the above analysis, the level of NPAs is high with all banks currently and the banks would be expected to bring down their NPA. This can be achieved by good credit appraisal procedures, effective internal control systems along with their efforts to improve asset quality in their balance sheets.
  3. However, maintaining profitability is a challenge to commercial banks especially in a highly competitive era and opening up of banking business to NBFC and foreign banks in general. This assumes significance in a period of rising interest rates and operating costs of borrowers in general.
  4. Banks would make efforts to mobilise funds in order to comply with provisioning norms and capital adequacy requirements while meeting Basel III standards which will be brought in by RBI shortly. However, the Capital requirements would be large considering the varied structure of banks and financial institutions operating in the economy and their NPA levels. The capital market environment currently prevailing in the economy would pose problems for the capital mobilization by the banks.
  5. Finally, it is significant to note that new and private sector banks led by ICICI Bank and HDFC Bank, with their high capital adequacy ratios, enhanced proportion of common equity and better IT and other modern financial skills of the personnel, are well placed to comply with Basel III norms in general. PSU banks although dominant banks in the Indian financial system may take more time and face challenges in following the Basel III guidelines in the ensuing years.

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Anirban Kar

Anirban Kar is a technology and business consultant, who has earned his education degree in two continents, the USA and from India. His work started from 2003 in TCS, and comprised
of various clients ranging across geographies. His area of interest is business modeling,
enterprise architecture and investment analysis.