Non Performing Assets Jims
Transcript of Non Performing Assets Jims
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Non Performing Assets:
An asset, including a leased asset, becomes non-performing when it ceases to generate income
for the bank. A non-performing asset is a loan or advance where:
y Interest and / or installment of principal remain overdue for a period of more than 90 daysy The account remains out of order in respect of an Overdraft/Cash/Cash Credit
(OD/OC).
y The bill remains overdue for a period of more than 90 days in the case of bills purchasedand discounted.
y A loan granted for short duration crops will be treated as NPA, if the installment ofprincipal or interest thereon remains overdue for two crop seasons.
y A loan granted for long duration crops will be treated as NPA, if the installment ofprincipal or interest thereon remains overdue for one crop season.
y Banks should classify an account as BNPA only if the interest charged during any quarteris not serviced fully within 90 days from the end of the quarter.
Net NPA as percentage of net advances
Net Non Performing Assets (NPAs) are gross NPAs net of provisions on NPAs and suspense
account. Net NPA is obtained by deducting items like interest due but not recovered, part
payment received and kept in suspense account etc., from Gross NPA.
Asset Classification:
Banks are required to classify non-performing assets further into following three categories
based on the period for which the asset has remained non-performing and the reliability of the
dues.
y Sub-standard Assets: With effect from 31.03.2005, a sub-standard asset would be onewhich has remained NPA for a period less than or equal to 12 months.
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y Doubtful Assets: With effect from 31.03.2005, a doubtful asset would be one which hasremained in the sub-standard category for a period of 12 months.
y Loss assets: A loss asset is one where loss has been identified by the bank or internal orexternal auditors or the RBI inspection but the amount has not been written off wholly.
The classification of assets and provisioning norms as per the extant guidelines and as detailed
above could be summarized as depicted in the following table.
Classification of Assets Description Provisioning Norms
Standard Assets Otherwise known as
performing assets
0.40% on standard assets
0.25% on direct advances to
agriculture and SME 1.00%
on personal loans, capital
market exposures, residential
houses beyond Rs. 20 lacs
and commercial real estate
Sub-standard Assets NPAs up to a period of 2
years
10 % on total outstanding
irrespective of security
coverage/ guarantee. The
unsecured portion will attract
additional provision of 10
percent.
Doubtful Assets NPAs over two years 100 % shortfall in the
securities and 20%/ 30%
60%/ 100% depending upon
the age of the asset
Loss Assets NPAs in which there waslittle/ negligible realizable
value of security
100% of balance outstanding
Reasons for NPAs in Banks
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An account does not become an NPA overnight. It gives signals sufficiently in advance that steps
can be taken to prevent the slippage of the account into NPA category. An account becomes an
NPA due to causes attributable to the borrower, the lender and for reasons beyond the control of
both.
Attributable to the Borrower / Project
The following is a list of factors attributable to the borrower, which could account for the
borrower's accounts becoming non-performing assets:
y Financial losses for two years consecutively.y Poor management and marketing strategy, poor assessment of demand, over capacity for
the product, lack of commitment, entering a declining market, price war, etc.
y Diversion of funds within and outside the business or project. Sometimes funds arediverted for another project.
y Differences and disputes among promoters/directors.y The bandwagon effect. People with little experience in the field enter a profession just
because others have succeeded recently. This is common in the construction, real estate
and hospitality industries.
y High cost base evidenced by labor costs, low productivity, distribution costs, rawmaterial cost, high reorganization cost.
y Inadequate financial control demonstrated by poor debt management/structure.y Inadequate information which is demonstrated by the following - poorly prepared
budgets or no budgets, no costing/unit costs, limited analysis/planning for stocks, capital
expenditure not planned/budgeted.
y Time and cost overrun due to poor supervision and control over the project by thepromoters.
y Increasing low margin sales, debtor provisions, currency losses, creditor pressure, andshort-term debt. Emphasis on cash sales with little regard for profit.
y Borrowing to pay operational expenses like electricity, wages, etc.y Recurrence of problems previously resolved.y Maintenance of expensive offices/keeping premises in a continuous state of neglect.
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y Short term loans / ad hoc loans/excess over limits continuing beyond due date.y Qualified audit opinion.y Unable to comply with loan covenants.y Liquidity ratios reveal deteriorating trends.y Increase in creditors days outstanding.y Speculative investmentsy However, there are also external factors over which the borrower has no control and these
could also lead to non-performing assets. These external factors could include:
y Delay in financial closure.y Delay in realization of receivables.y Exchange rate fluctuations.y Depressed capital market.y General recession in the particular industry.y Changes in personal habits of promoters/key people.
Fraud is also a contributory factor to cases of NPAs. The following are all signs of fraud that
need to be recognized in order to prevent NPAs.
y Sales/inventory/assets overstated, liabilities understated.y Audits cease.y Abnormally large fund transfers.y Significant cash balances in non-interest earning accounts.y Management overrides internal controls.y Sale of assets to related parties.y Unusual supplier relationships.y Staff working unusually long working hours.
Attributable to the Bank
y Deficiency in credit assessment and monitoring system.y Improper valuation of securities at the time of appraisal of loans.
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y Failure in verification of end use of the loans and improper follow-up of and inadequateperiodical verifications.
y Inadequacy/ deficiency insecurity creation/ documentation at the time of disbursal ofloans.
y Laxity in taking timely corrective measures when an asset emits distress signals.y Delay in decision making regarding rendering of further assistance.y Excess/short lending.y Non-adoption of appropriate resolution strategy for tackling of NPA accounts.y Managerial deficiencies or incompetence of the borrowers.y Delay in implementation of the projects leading to cost escalation.y Diversification/siphoning of funds.y Willful default of the borrower.
External / Others
y Lack of demand for the product in market and downward trend in sales.y Increase in rate of interest.y Delay in implementation of rehabilitation programme.y Borrower friendly legal environment for recovery of defaulted loans.y Change in the overall economic environment of the country.
Steps needed to reduce NPA
y Arresting slippage of accounts through relentless monitoring and focus on the continuousviability of the borrowing concern with improved asset classification is must. At the same
time all accounts in the Standard category should not be taken for granted and should be
subjected to periodical and in-depth review in a systematic manner through a sound
adequate loan review mechanism in place.
y Categorization of standard accounts into A, B, C based on actual recovery of interest andinstallments due, will help a focused and strengthened monitoring.
y Banks should ensure that they should move with speed and charged with momentum indisposing off the loss assets. This is because as uncertainty increases with the passage of
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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.
y Bank should adhere to Know Your Customer norms for identification of borrower,guarantor and verification of their addresses to minimize the risk of default in case of
housing sector lending. In respect of agricultural advances, recovery camp should be
organized during the harvest season.
y Ongoing monitoring of banks borrowers is important to understand the primary cause ofcorporate decline and to be able to identify the symptoms of a potential distress situation.
Loan Officers and staff should be alert and diligent for signs of borrower distress. It is
essential to identify signs of distress which diminish the Borrowers capacity to repay
debt. Early recognition followed by appropriate action is essential if the bank is to
minimize NPAs.
y Loan Workout Unit should be created which should be exclusively responsible formanaging non-performing and under performing loans to maximize the recovery value
from a portfolio of distressed loans, through the employment of an equitable and
professional workout process.
Doubtful AssetsExample
Existing stock of advances classified as doubtful more than 3 years as on March 2004
The outstanding amount as on 31 march 2004 Rs. 25,000
Realizable value of security: Rs 20,000
Period for which the advance has remained in doubtful category as on 31 March 2004:
4years (i;e doubtful more than 3 years)
Provisioning requirement:
As on --- Provisions on Secured
portion% Amount
Provisions on Secured
portion% Amount
Total (Rs)
31 March
2004
50 10,000 100 5,000 15,000
31 March 60 12,000 100 5,000 17,000
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2005
31 March
2006
75 15,000 100 5,000 20,000
31 March
2007
100 20,000 100 5,000 25,000
Sub Standard Assets
A general provision of 10% on total outstanding to be made (without making any allowance for
ECGC guarantee cover and securities available) . The unsecured exposures identified as sub
standard would attract additional provision of 10 percent thus constituting 20 % on the
outstanding balance.
Unsecured exposure is defined as an exposure where the realizable value of the security, as
assessed by the bank/approved valuers/ Reserve Banks inspecting officers, is not more than 10
percent of the outstanding advances. Exposure should include all funded and non funded
exposures (including underwriting and similar commitments). Security will mean tangible
security properly discharged to the bank and will not include intangible securities like
guarantees, and comfort letters.
Provisions where ECGC Guarantee is available
In the case of advances classified as doubtful and guaranteed by ECGC, provision should be
made only for the balance in excess of the amount guaranteed by the corporation. While arrivingat the provision required to be made for doubtful assets, realizable value of the securities should
be declared from the outstanding balance in respect of the amount guaranteed by the corporation
before provisioning.
Example: Hypothetical Case
Outstanding balance Rs.4 lakh
ECGC cover 50 percent
Period for which advance has remained
doubtful
More than 3 years remained doubtful(as on 31
March 2004)
Value of security held Rs. 1.50 Lakh
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Provisions required to be made
Outstanding balance Rs. 4 Lakh
Less: Value of security held Rs. 1.50 Lakh
Unrealised balance Rs. 2.50 Lakh
Less: ECGC Cover (50% of unrealizable
balance)
Rs. 1.25 Lakh
Net Unsecured portion of advance Rs. 1.25 Lakh
Provision for secured portion of advance Rs. 1.25 Lakh (@ 100% of unsecured portion)
Provision for secured portion of advance (as on
31 March 2005)
Rs. 0.90 Lakh (@ 60 % of the secured portion)
Total Provisions to be made Rs. 2.15 Lakh (as on March 2005)
Format for reporting NPAs to RBI
Reporting Format for NPA-Gross and Net Position
Name of the Bank:
Position as on -------------------------
(Rupees in crore up to two decimals)
Particulars Amount
1. Gross advances2. Gross NPA3. Gross NPA as % of gross advances4.
Total Deductions(1+2+3+4)
a. Balance in interest suspense accountb. DICGC/ECGC claims received and held pending adjustmentc. Part payment received and kept in suspense accountd. Total Provisions held
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5. Net Advances (1-4)6. Net NPA (2-4)7. Net NPA as % of Net Advances
Gross advances mean all outstanding loans and advances including advances for which refinance
has been received but excluding rediscounted bills, and advances written off at head office level
(technical write- off).
Note: Provisions made for NPA are not eligible for tax deduction but tax benefits can be enjoyed
by the bank for claiming write-off advances.
Writing off NPAs
Example explains the impact of provisioning and write-off on banks profits
Profit before provisioning forBank A is Rs. 500 crore. If the tax rate is 30 percent , what will bethe impact of the following actions on Bank As a. Profits and b. capital base.
Make a provision of Rs. 250 crore for NPAs
Options:
Provide Rs. 200 crore for NPAs and
Write off the remaining Rs. 50 crore
Option 1: Provide for Rs. 250 crore for NPAs
Profit before provision Rs. 500 crore
Less provision for NPAs Rs. 250 crore
Profit before Tax Rs. 250 crore
Less Tax at 30% Rs. 150 crore (since provision for NPAs not tax deductible, tax
calculated at 30% of Rs. 500 crore)
Profit AfterTax Rs.100 crore
Option 2: Provide for Rs. 200 crore for NPAs and write -off Rs. 50 crore
Profit before provision Rs. 500 crore
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Less provision for NPAs Rs. 200 crore
Less Write-off Rs. 50 crore
Profit before Tax Rs. 250 crore
Less Tax at 30% Rs. 135 crore (since write-off for NPAs are tax deductible, tax
calculated on profit before tax + provisions = Rs. 450 crore)
Profit AfterTax Rs.115 crore
Interpretation:
Option 2 yields more profits after tax and hence would augment the capital base more than
Option 1.