NON PERFORMING ASSETS – CHALLENGES TO PUBLIC SECTOR BANK

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DECLARATION

I hereby declare that the work incorporated in the present research project

entitled ”NON PERFORMING ASSETS – CHALLENGES TO PUBLIC

SECTOR BANK” is my own work and original. This work (in Part or in full)

has not been submitted to any University for the award of a degree.

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PREFACE

To excel in any field practical training is an integral part to imply theoretical studies to a

practical approach.

It make as the individual to the actual practical condition, which could have been

impossible to be taught in classroom. A trainee learns dealing with the client and

management working environment along with today’s market, which is changing at

incredible pace.

In addition, technological changes, which we are witnessing, have shifted the old hectic

and weird ways of doing businesses. These technological developments have brought

revolutionary change in the market and in the mindset of the people, which are positive,

encouraging for as section of society, and adverse for others.

I am thankful to the management for assigning such a challenging topic of: NON

PERFORMING ASSETS – CHALLENGES TO PUBLIC SECTOR BANK.

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ACKNOWLEDGEMENT

“No man is perfect; every one requires help and assistance of others”

Feeling and writing something good for exclusively good people by few

people is something live, expressions fainting in the boundaries of words. An

effort for the same is here.

I express my sincere thanks to my project guide, Mr. A.K. GUPTA,

Assistant professor, Finance, for guiding me right from the inception till

the successful completion of the project. I sincerely acknowledge

him/her/them for extending their valuable guidance, support for literature,

critical reviews of project and the report and above all the moral support

he/she/they had provided to me with all stages of this project.

I would also like to thank the supporting staff of finance Department, for

their help and cooperation throughout our project.

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EXECUTIVE SUMMARY

After liberalization the Indian banking sector developed very appreciate. The RBI also

nationalized good amount of commercial banks for proving socio economic services to the

people of the nation.

The Public Sector Banks have shown very good performance as far as the financial operations

are concerned. The only problem of the Public Sector Banks these days are the increasing level

of the non performing assets. The non performing assets of the Public Sector Banks have been

increasing regularly year by year.

The only problem that hampers the possible financial performance of the Public Sector Banks is

the increasing results of the non performing assets. The non performing assets impacts

drastically to the working of the banks. The efficiency of a bank are not always reflected only by

the size of its balance sheet but by the level of return on its assets. NPAs do not generate

interest income for the banks, but at the same time banks are required to make provisions for

such NPAs from their current profits.

NPAs have a deleterious effect on the return on assets in several ways –

• They erode current profits through provisioning requirements

• They result in reduced interest income

• They require higher provisioning requirements affecting profits and accretion to capital funds

and capacity to increase good quality risk assets in future, and

• They limit recycling of funds, set in asset-liability mismatches, etc.

NPA The three letters Strike terror in banking sector and business circle today. NPA is short

form of “Non Performing Asset”. The dreaded NPA rule says simply this: when interest or other

due to a bank remains unpaid for more than 90 days, the entire bank loan automatically turns a

non performing asset. The recovery of loan has always been problem for banks and financial

institution. To come out of these first we need to think is it possible to avoid NPA, no cannot be

then left is to look after the factor responsible for it and managing those factors.

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Objective of this report is to know why NPAs are the great challenge to the Public Sector

Banks, to understands what is Non Performing Assets and what are the underlying reasons for

the emergence of the NPAs, to understand the impacts of NPAs on the operations of the Public

Sector Banks, to know what steps are being taken by the Indian banking sector to reduce the

NPAs? And to evaluate the comparative ratios of the Public Sector Banks with concerned to the

NPAs.

Research design for this study the primary data would not be useful until and unless they are

well edited and tabulated. When the person receives the primary data many unuseful data

would also be there. So, I analysed the data and edited them and turned them in the useful

tabulations. So, that can become useful in my report study.

The primary data would not be useful until and unless they are well edited and tabulated. When

the person receives the primary data many unuseful data would also be there. So, I analysed

the data and edited them and turned them in the useful tabulations. So, that can become useful

in my report study.

Recommendations of the study that Each bank should have its own independent credit rating

agency which should evaluate the financial capacity of the borrower before than credit facility.

The credit rating agency should regularly evaluate the financial condition of the clients. Special

accounts should be made of the clients where monthly loan concentration reports should be

made. No loan is to be given to a Group whose one or the other undertaking has become a

Defaulter.

Conclusion of the Study The NPA is one of the biggest problems that the Public Sector Banks

are facing today is the problem of nonperforming assets. If the proper management of the

NPAs is not undertaken it would hamper the business of the banks. In absolute terms, the last

three years have seen an increase in the net NPAs of 25 public sector banks by 24 per cent.

According to the numbers, the last year it saw a 17 percent rise in the sticky assets. The RBI

has also been trying to take number of measures but the ratio of NPAs is not decreasing of the

banks. The banks must find out the measures to reduce the evolving problem of the NPAs.

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TABLE OF CONTENT

Declaration…………………………………………………

Certificate……………………………………………………………

Acknowledgement…………………………………………………

Executive Summary………………………………………………..

CHAPTER—1 INTRODUCTION

INDIAN BANKING SECTOR

INDIAN BANKING INDUSTRY

MAJOR DEVELOPMENTS IN BANKING AND FINANCE

PUBLIC SECTOR BANK

CHELLENGES FOR PUBLIC SECTORS BANK

NON PERFORMING ASSETS

FACTORS FOR RISES IN NPA

INDIAN ECONOMY AND NPA

UNDERLINE REASONS NPA IN INDIA

RECOVERY TOOL AND THEIR EFFECTIVENES

Chapter – 2 REVIEW OF LITERATURE

Chapter – 3 RESEARCH METHODOLOGY

SIGNIFICANCE OF THE STUDY

OBJECTIVE OF RESEARCH

RESEARCH METHDOLOGY

LIMITATIONS OF THE STUDY

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Chapter – 4 ANALYSIS AND INTERPRETATION

Chapter – 5 FINDINGS, RECOMMENDATIONS AND

CONCLUSIONS

APPENDICES

A.1 BIBLIOGRAPHY

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INTRODUCTION

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INTRODUCTION

After liberalization the Indian banking sector developed very appreciate. The RBI also

nationalized good amount of commercial banks for proving socio economic services to the

people of the nation.

The Public Sector Banks have shown very good performance as far as the financial operations

are concerned. If we look to the glance of the financial operations, we may find that deposits of

public to the Public Sector Banks have increased from 859,461.95crore to 1,079,393.81crore in

2003, the investments of the Public Sector Banks have increased from 349,107.81crore to

545,509.00crore, and however the advances have also been increased to 549,351.16crore from

414,989.36crore in 2003.

The total income of the public sector banks have also shown good performance since the last

few years and currently it is 128,464.40crore. The Public Sector Banks have also shown

comparatively good result. The gross profits of the Public Sector Banks currently 29,715.26crore

which has been doubled to the last to last year, and the net profit of the Public Sector Banks is

12,295,47crore.

However, the only problem of the Public Sector Banks these days are the increasing level of the

non performing assets. The non performing assets of the Public Sector Banks have been

increasing regularly year by year. If we glance on the numbers of nonperforming assets we may

come to know that in the year 1997 the NPAs were 47,300crore and reached to 80,246crore in

2002.

The only problem that hampers the possible financial performance of the Public Sector Banks

is the increasing results of the non performing assets. The non performing assets impacts

drastically to the working of the banks. The efficiency of a bank is not always reflected only by

the size of its balance sheet but by the level of return on its assets. NPAs do not generate

interest income for the banks, but at the same time banks are required to make provisions for

such NPAs from their current profits.

NPAs have a deleterious effect on the return on assets in several ways –

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• They erode current profits through provisioning requirements

• They result in reduced interest income

• They require higher provisioning requirements affecting profits and accretion to capital funds

and capacity to increase good quality risk assets in future, and

• They limit recycling of funds, set in asset-liability mismatches, etc.

The RBI has also tried to develop many schemes and tools to reduce the non performing

assets by introducing internal checks and control scheme, relationship managers as stated by

RBI who have complete knowledge of the borrowers, credit rating system, and early warning

system and so on. The RBI has also tried to improve the securitization Act and SRFAESI Act

and other acts related to the pattern of the borrowings.

Though RBI has taken number of measures to reduce the level of the non performing assets

the results is not up to the expectations. To improve NPAs each bank should be motivated to

introduce their own precautionary steps. Before lending the banks must evaluate the feasible

financial and operational prospective results of the borrowing companies. They must evaluate

the business of borrowing companies by keeping in considerations the overall impacts of all the

factors that influence the business.

INDIAN BANKING SECTOR

Banking in India has its origin as early as the Vedic period. It is believed that the transition from

money lending to banking must have occurred even before Manu, the great Hindu Jurist, who

has devoted a section of his work to deposits and advances and laid down rules relating to rates

of interest. During the Mogul period, the indigenous bankers played a very important role in

lending money and financing foreign trade and commerce. During the days of the East India

Company, it was the turn of the agency houses to carry on the banking business. The General

Bank of India was the first Joint Stock Bank to be established in the year 1786. The others

which followed were the Bank of Hindustan and the Bengal Bank. The Bank of Hindustan is

reported to have continued till 1906 while the other two failed in the meantime. In the first half of

the 19thcentury the East India Company established three banks; the Bank of Bengal in 1809,

the Bank of Bombay in 1840 and the Bank of Madras in 1843. These three banks also known as

Presidency Banks were independent units and functioned well. These three banks were

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amalgamated in 1920 and a new bank, the Imperial Bank of India was established on 27th

January 1921. With the passing of the State Bank of India Act in 1955 the undertaking of the

Imperial Bank of India was taken over by the newly constituted State Bank of India. The

Reserve Bank which is the Central Bank was created in 1935 by passing Reserve Bank of India

Act 1934. In the wake of the Swadeshi Movement, a number of banks with Indian management

were established in the country namely, Punjab National Bank Ltd, Bank of India Ltd, Canara

Bank Ltd, Indian Bank Ltd, the Bank of Baroda Ltd the Central Bank of India Ltd. On July 19,

1969, 14 major banks of the country were nationalised and in 15th April 1980 six more

commercial private sector banks were also taken over by the government

Indian Banking: A Paradigm shift-A regulatory point of view

The decade gone by witnessed a wide range of financial sector reforms, with many of them still

in the process of implementation. Some of the recently initiated measures by the RBI for risk

management systems, anti money laundering safeguards and corporate governance in banks,

and regulatory framework for non bank financial companies, urban cooperative banks,

government debt market and forex clearing and payment systems are aimed at streamlining the

functioning of these instrumentalities besides cleansing the aberrations in these areas. Further,

one or two all India development financial institutions have already commenced the process of

migration towards universal banking set up. The banking sector has to respond to these

changes, consolidate and realign their business strategies and reach out for technology support

to survive emerging competition. Perhaps taking note of these changes in domestic as well as

international arena.

All of we will agree that regulatory framework for banks was one area which has seen a sea-

change after the financial sector reforms and economic liberalisation and globalisation

measures were introduced in 1992-93. These reforms followed broadly the approaches

suggested by the two Expert Committees both set up under the chairmanship of Shri M.

Narasimham in 1991 and 1998, the recommendations of which are by now well known. The

underlying theme of both the Committees was to enhance the competitive efficiency and

operational flexibility of our banks which would enable them to meet the global competition as

well as respond in a better way to the regulatory and supervisory demand arising out of such

liberalisation of the financial sector. Most of the recommendations made by the two Expert

Committees which continued to be subject matter of close monitoring by the Government of

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India as well as RBI have been implemented. Government of India and RBI have taken several

steps to:-

(a) Strengthen the banking sector,

(b) Provide more operational flexibility to bank

(c) Enhance the competitive efficiency of banks, and

(d) Strengthen the legal framework governing operations of banks.

Regulatory measures taken to strengthen the Indian Banking sectors

The important measures taken to strengthen the banking sector are briefly, the following:

• Introduction of capital adequacy standards on the lines of the Basel norms,

• Prudential norms on asset classification, income recognition and provisioning,

• Introduction of valuation norms and capital for market risk for investments

• Enhancing transparency and disclosure requirements for published accounts,

• Aligning exposure norms – single borrower and group-borrower ceiling – with inter-national

best practices

• Introduction of off-site monitoring system and strengthening of the supervisory framework for

banks.

(A) Some of the important measures introduced to provide more operational flexibility to

banks are:

• Besides deregulation of interest rate, the boards of banks have been given the authority to fix

their prime lending rates. Banks also have the freedom to offer variable rates of interest on

deposits, keeping in view their overall cost of funds.

• Statutory reserve requirements have significantly been brought down.

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• The quantitative firm-specific and industry-specific credit controls were abolished and banks

were given the freedom to deploy credit, based on their commercial judgment, as per the policy

approved by their Boards.

• The banks were given the freedom to recruit specialist staff as per their requirements,

• The degree of autonomy to the Board of Directors of banks was substantially enhanced.

• Banks were given autonomy in the areas of business strategy such as, opening of branches /

administrative offices, introduction of new products and certain other operational areas.

(B) Some of the important measures taken to increase the competitive efficiency of banks are

the following:

• Opening up the banking sector for the private sector participation.

• Scaling down the shareholding of the Government of India in nationalised banks and of the

Reserve Bank of India in State Bank of India.

(C) Measures taken by the Government of India to provide a more conducive legal

environment for recovery of dues of banks and financial institutions are:

• Setting up of Debt Recovery Tribunals providing a mechanism for expeditious loan recoveries.

• Constitution of a High Power Committee under former Justice Shri Eradi to suggest

appropriate foreclosure laws.

• An appropriate legal framework for securitisation of assets is engaging the attention of the

Government

THE INDIAN BANKING INDUSTRY

The origin of the Indian banking industry may be traced to the establishment of the Bank of

Bengal in Calcutta (now Kolkata) in 1786. Since then, the industry has witnessed substantial

growth and radical changes. As of March 2002, the Indian banking industry consisted of 97

Commercial Banks, 196 Regional Rural Banks, 52 Scheduled Urban Co-operative Banks, and

16 Scheduled State Co-operative Banks.

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The growth of the banking industry in India may be studied in terms of two broad phases: Pre

Independence (1786-1947), and Post Independence (1947 till date). The post independence

phase may be further divided into three sub-phases:

• Pre-Nationalisation Period (1947-1969)

• Post-Nationalisation Period (1969-1991)

• Post-Liberalisation Period (1991- till date)

The two watershed events in the post independence phase are the nationalisation of banks

(1969) and the initiation of the economic reforms (1991). This section focuses on the evolution

of the banking industry in India post-liberalisation.

1. Banking Sector Reforms - Post-Liberalisation

In 1991, the Government of India (Gol) set up a committee under the chairmanship of Mr.

Narasimaham to make an assessment of the banking sector. The report of this committee

contained recommendations that formed the basis of the reforms initiated in 1991. The banking

sector reforms had the following objectives:

1. Improving the macroeconomic policy framework within which banks operate;

2. Introducing prudential norms;

3. Improving the financial health and competitive position of banks;

4. Building the financial infrastructure relating to supervision, audit technology and legal

framework; and

5. Improving the level of managerial competence and quality of human resources.

1.1 Impact of Reforms on Indian Banking Industry

With the initiation of the reforms in the financial sector during the 1990s, the operating

environment of banks and term-lending institutions has radically transformed. One of the fall-

outs of the liberalisation was the emergence of nine new private sector banks in the mid1990s

that spurred the incumbent foreign, private and public sector banks to compete more fiercely

than had been the case historically. Another development of the economic liberalisation process

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was the opening up of a vibrant capital market in India, with both equity and debt segments

providing new avenues for companies to raise funds. Among others, these two factors have had

the greatest influence on banks operating in India to broaden the range of products and services

on offer. The reforms have touched all aspects of the banking business. With increasing

integration of the Indian financial markets with their global counterparts and greater emphasis

on risk management practices by the regulator, there have been structural changes within the

banking sector. The impact of structural reforms on banks' balance sheets (both on the asset

and liability sides) and the environment they operate in is discussed in the following sections.

1.2 Reforms on the Liabilities Side

• Reforms of Deposit Interest Rate

Beginning 1992, a progressive approach was adopted towards deregulating the interest rate

structure on deposits. Since then, the rates have been freed gradually. Currently, the interest

rates on deposits stand completely deregulated (with the exception of the savings bank deposit

rate). The deregulation of interest rates has helped Indian banks to gain more control on the

cost of their deposits, the main source of funding for Indian banks. Besides, it has given more,

flexibility to banks in managing their Asset-Liability positions.

• Increase in Capital Adequacy Requirement

During the 1990s, the Reserve Bank of India (RBI) adopted a strategy aimed at all banks

attaining a Capital Adequacy Ratio (CAR) of 8% in a phased manner. On the recommendations

of the Committee on Banking Sector Reforms, the minimum CAR was further raised to 9%,

effective March 31, 2000.While the stipulation of a higher Capita! Adequacy' Ratio has

increased the capital requirement of banks; it has provided more stability to the Indian banking

system.

1.3 Reforms on the Asset Side

• Reforms on the Lending Interest Rate

During 1975-76 to 1980-81, the RBI prescribed both the minimum lending rate and the ceiling

rate. During 1981-82 to 1987-88. The RBI prescribed only the ceiling rate. During 198889 to

1994-95, the RBI switched from prescribing a ceiling rate to fixing a minimum lending rate. From

1991 onwards, interest rates have been increasingly freed. At present, banks can offer loans at

rates below the Prime Lending Rate (PLR) to exporters or other creditworthy borrowers

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(including public enterprises), and have only to announce the FLR and the maximum spread

charged over it. The deregulation of lending rates has given banks the flexibility to price loan

products on the basis of their own business strategies and the risk profile of the borrower. It has

also lent a competitive advantage to banks with lower cost of funds.

• Lower Cash Reserve and Statutory Liquidity Requirements

During the early 1980s, statutory pre-emption in the form of Cash Reserve Ratio (CRR) and

Statutory Liquidity Ratio (SLR) accounted for 42% of the deposits. In the 1990s, the figure rose

to 53.5%, which during the post-liberalisation period has been gradually reduced. At present,

banks are required to maintain a CRR of 4% of the Net Demand and Time Liabilities (NDTL)

(excluding liabilities subject to zero CRR prescriptions). The RBI has indicated that the CRR

would eventually be brought down to the statutory minimum level of 3% over a period of time.

The SLR, which was at a peak of 38.5% during September 1990 to December 1992, now

stands lower at the statutory minimum of 25%.A decrease in the CRR and SLR requirements

implies an increase in the share of deposits available to banks for loans and advances. It also

means that bank's now have more discretion in the allocation of funds, which if deployed

efficiently, can have a positive impact on their profitability. By increasing the amount of invisible

funds available to banks, the reduction in the CRR and SLR requirements has also enhanced

the need for efficient risk management systems in banks.

• Asset Classification and Provisioning Norms

Prudential norms relating to asset classification have been changed post-liberalisation. The

earlier practice of classifying assets of different quality into eight `health codes" has now been

replaced by the system of classification into four categories (in accordance with the international

norms): standard, sub-standard, doubtful, and loss assets. On 1st April 2000, provisioning

requirements of a minimum of 0.25% were introduced for standard assets. For the sub-

standard, doubtful and loss asset categories, the provisioning requirements remained at 10%,

20-50% (depending on the duration for which the asset has remained doubtful), and 100%,

respectively, the recognition norms for NPAs have also been tightened gradually. Since March

1995, loans with interest and/or instalment of principal overdue for more than 180 days are

classified as non-performing. This period will be shortened to 90 days from the year ending 31st'

March 2004.

1.4 Structural Reforms

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• Increased Competition

With the initiation of banking-sector reforms, a more competitive environment has been

ushered in. Now banks are not only competing within themselves, but also with non-banks, such

as financial services companies and mutual funds. While existing banks have been allowed

greater flexibility in expanding their operations, new private sector banks have also been

allowed entry. Over the last decade nine new private sector banks have established operations

in the country. Competition amongst Public Sector Banks (PSBs) has also intensified. PSBs are

now allowed to access the capital market to raise funds. This has diluted Government's

shareholding, although it remains the major shareholder in PSBs, holding a minimum 51% of

their total equity.

Although competition in the banking sector has reduced the share of assets and deposits of the

PSBs, their dominant positions, especially of the large ones, continues. Although the PSBs will

remain major players in the banking industry, they are likely to face tough competition, from both

private sector banks and foreign banks. Moreover, the banking industry is likely to face stiff

competition from other players like non-bank finance companies, insurance companies, pension

funds and mutual funds. The increasing efficiency of both the equity and debt markets has also

accelerated the process of financial disintermediation, putting additional pressure on banks to

retain their customers. Increasing competition among banks and financial intermediaries is likely

to reduce the Net Interest Spread of banks.

• Banks entry into New Business Lines

Banks are increasingly venturing into new areas, such as, Insurance and Mutual Funds, and

offering a wider bouquet of products and services to satisfy the diverse needs of their

customers. With the enactment of the Insurance Regulatory and Development Authority (IRBA)

Act, 1999, banks and NBFCs have been allowed to enter the insurance business. The RBI has

also issued guidelines for-banks' entry into insurance, according to which, banks need to obtain

prior approval of the RBI to enter the insurance business. So far, the RBI has accorded its

approval to three of the 39 commercial banks that had sought entry into insurance. Insurance

presents a new business opportunity for banks. The opening up of the insurance business to

banks is likely to help them emerge as financial supermarkets like their counterparts in

developed countries.

• Increased thrust on Banking Supervision and Risk Management

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To strengthen banking supervision, an independent Board for Financial Supervision (BFS)

under the RBI was constituted in November 1994. The Board is empowered to exercise

integrated supervision over all credit institutions in the financial system, including select

Development Financial Institutions (DFIs) and Non Banking Financial Companies (NBFCs),

relating to credit management, prudential norms and treasury operations. A comprehensive

rating system, based on the CAMELS methodology, has also been instituted for domestic

banks; for foreign banks, the rating system is based on CACS. This rating system has been

supplemented by a technology-enabled quarterly off- site surveillance system.

To strengthen the Risk Management Process in banks, in line with proposed Basel 11 accord,

the RBI has issued guidelines for managing the various types of risks that banks are exposed

to. To make risk management an integral part of the Indian banking system, the RBI has also

issued guidelines for Risk based Supervision (RBS) and Risk based Internal Audit (RBIA).

These reform initiatives are expected to encourage banks to allocate funds across various lines

of business on the basis of their Risk adjusted Return on Capital (RAROC). The measures

would also help banks be in line with the global best practices of risk management and enhance

their competitiveness.

The Indian banking industry has come a long way since the nationalisation of banks in 1969.

The industry has witnessed great progress, especially over the past 12 years, and is today a

dynamic sector. Reforms in the banking sector have enabled banks explore new business

opportunities rather than remaining confined to generating revenues from conventional streams.

A wider portfolio, besides the growing emphasis on consumer satisfaction, has led to the Indian

banking sector reporting robust growth during past few years.

It is clear that the deregulation of the economy and of the Banking sector over the last decade

has ushered in competition and enabled Indian banks to better take on the challenges of

globalisation.

1.5 Operational and Efficiency Benchmarking

• Benchmarking of Return on Equity

Return on Equity (ROE) is an indicator of the profitability of a bank from the shareholder's

perspective. It is a measure of Accounting Profits per unit of Book Equity Capital. The ROE of

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Indian banks for the year ended 31st March 2003, was in the range of 14 - 40%; the median

ROE. Being 23.72% for the same period. On the other hand, the global benchmark banks had a

median ROE of 12.72% for the year ended 31st December 2002.

In recent years, Indian banks have reported unusually high trading incomes, driven mainly by

the scope to booking profits that arise from a sharply declining interest rate environment.

However, such high trading income may not be sustainable in future. The adjusted median ROE

for Indian banks (adjusted for trading income) stands at 5.42% for Indian banks for FY2003 as

compared with 11.77% for the global benchmark banks. After adjusting for trading income, the

median ROE of Indian hanks stands lower than the same for the global benchmark banks, thus

implying that the contribution of trading income to the ROE of Indian banks is significant.

Further, the ROE benchmarking method favours banks that operate with low levels of equity or

high leverage. To assess the impact of the leverage factor on the ROE of banks, "Equity

Multiplier” is presented in the next section.

• Benchmarking of Equity Multiplier

Equity Multiplier (EM) is defined as "Total Assets divided by Net Worth". This is the reciprocal of

the Capital-to-Asset ratio, which indicates the leverage of a bank (amount of Assets of a bank

pyramided on its equity capital). Banks with a higher leverage will be able to post a higher ROE

with a similar level of Return on Asset (ROA), because of the multiplier effect. However, the

banking industry is safer with a lower leverage or a higher proportion of equity capital in the total

liability. Capital is important for banks for two main reasons:

Firstly, capital is viewed as the ultimate line of protection against any potential loss credit,

market, or operating risks. While loan and investment provisions are associated with expected

losses, capital is a cushion against unexpected losses.

Secondly, capital allows banks to pursue their growth objectives; a bank has to maintain a

minimum capital adequacy ratio in accordance with regulatory requirements. A bank with

insufficient capital may not be able to take advantage of growth opportunities offered by the

external operating environment the same way as another bank with a higher capital base could.

• Benchmarking of Return on Assets

ROA is defined as Net Income divided by Average Total Assets. The ratio measures a bank's

Profits per currency unit of Assets. The median ROA for Indian banks was 1.15% for FY2003.

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For the global benchmark banks, the ROA ranged from 0.05% to 1.44% for the year ended

December 2002, with the median at 0.79%.

For the year ended December 2002, Bank of America reported the highest ROA (1.44%) among

the global benchmark banks, followed by City group Inc. (1.42%). The median value for Indian

banks at 1.15% was higher than that of ABN AMRO Bank, Deutsche Bank, Rabo Bank and

Standard Chartered Bank. Two banks, namely Bank of America and Citigroup Inc., posted

higher ROAs as compared with the European and other banks for both FY2003 and FY2002

primarily on the strength of higher Net Interest Margins. The reasons for the Net Interest

Margins being higher are discussed in the sections that follow.

As with the ROE analysis, here too adjustments for non-recurring income/expenses must be

made while comparing figures on banks' ROA. Adjusting for trading income, for both Indian

banks and the global benchmark banks, the median works out to be lower for Indian banks vis-

à-vis the global benchmark banks for FY 2003.

I have further analysed the effect of adjustment for trading income on the ROAs of both Indian

Banks and the Global Benchmark Banks. Here, it must be noted that the global benchmark

banks have a more diversified income portfolio as compared with Indian banks, and a decline in

interest rate could have increased profitability of global benchmark banks indirectly in more

ways than one. However, from the disclosures available in the annual reports of the global

banks, it is not possible to quantify the impact of declining interest rates on their profitability

(`thus, the same has not been adjusted for in this analysis). Nevertheless, to further analyse the

profitability (per unit of assets) of Indian banks vis-a-vis the global benchmark banks, ICRA has

conducted a ROA decomposition analysis.

1.6 Decomposition of Return on Assets

• Net Interest Margin

Net Interest Margin (NIM) measures the excess income of a bank's earnings assets (primarily

loans, fixed-income investments, and interbank exposures) over its funding costs. To the past,

for banks NIM was the main source of earnings, which were therefore directly correlated with

the margin levels. But with NIM declining significantly in many countries, banks are now trying to

compensate the "lost" margins with non-fund based fee incomes and trading income. Despite

these changes, net interest income continues to account for a significant share of the earnings

of most banks. The median NIM for Indian banks was 3.16% for FY2003 and 3.92% for FY2002.

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The figures compare favourably with those of the global benchmark banks. Before drawing

inferences on the NIM benchmarking results, three aspects must be considered, namely: (a)

The external operating environment, (b) The quality and type of assets, and (c) Accounting

policies followed by banks.

The three aspects are explored in detail in the subsequent paragraphs.

(a) External Operating Environment

Intermediation cost is a significant factor explaining the differences in NIMs across countries.

Interest margins tend to be higher in countries where the intermediation costs are high.

Generally, the absence of a vibrant capital market results in the intermediation costs being

higher. In India, the debt market is relatively less developed (as compared with the markets in

USA and Europe), and therefore, most corporate entities are dependent mainly on banks for

meeting their financing needs. As a result, Indian banks are able to command higher NIMs as

compared with the global benchmarks banks. To make a like-to-like comparison and understand

the impact of intermediation cost, ICRA has compared the NIMs of the Indian operations of the

global benchmark banks with those of Indian banks. Of the six global benchmark banks, the

local operations of four banks earned higher NIMs vis-a-vis the median of Indian banks in

FY2002 and FY2003. Of these four banks, three earned NIMs above 4%. This analysis

strengthens ICRA's hypothesis that the external operating environment is an important factor

while benchmarking NIMs.

(b) Type & Quality of Assets

The higher NIMs of US-based banks are attributable to their sharper focus on consumer loans

and credit cards as compared with European banks. Also, the high NIMs of US banks are the

cause for their comparatively high ROAs. To overcome the potential for higher provisions arising

from its strategy of lending to riskier assets, a bank may charge a higher rate of interest to its

borrowers (with a consequently higher NIM) than another bank. So while comparing the NIMs of

two banks, the effect of asset quality must be normalised. One way of doing this is to use Total

Risk Weighted Adjusts (RWA) instead of Total Assets as the denominator. However, many

Indian banks do not disclose their RWA values in their annual reports, and therefore, ICRA has

not been able to use this method in this study. The alternative method is to adjust the NIM for

provisions & contingencies. If the asset quality of a bank is relatively weak, it is likely to

generate higher Non-Performing Assets (NPAs). As a result, its provisions & contingencies are

22

also likely to be higher. Therefore, if the effect of asset quality is normalised by removing

provisions & contingencies from the NIM, a better understanding of the efficiency of the fund

based business of banks may be obtained. ICRA defined adjusted NIM as Net Interest Spread

(Net Interest Income less Provisions & Contingencies)/Average Total Assets]. The Net Interest

Spread's for the global benchmark banks ranged from 0.14 to 2.10% for the financial year

ended December 2002, with the median at 1.54%. The corresponding median figure for Indian

banks was 1.68%. The difference between the NIMs of the global benchmark banks and Indian

bank; reduces substantially after adjusting for provisions. This strengthens ICRA's hypothesis

that the type and quality of assets substantially affect NIM.

(3)Accounting Policies

The Net Interest Spreads adjusted for Provisions can vary substantially, depending on the

income recognition and provisioning norms. According to International Accounting Standard,

(IAS) provisioning for NPAs is based on management discretion,

Whereas in India, the RBI defines the provisioning requirement for impaired assets as a

function of time and security. An illustration of difference in accounting for NPA is that for Indian

banks, an asset is reckoned as NPA when principal or interest are past due for 180 days as

compared with 90 days for the global benchmark banks (the norms will converge with effect

from financial year 2004). Keeping in view the levels of NIM for Indian and global benchmark

banks, and the three factors analysed above, ICRA believes that the NIM for Indian banks is

comparable with that of the global benchmark banks.

• Non-Interest Income Ratio

Increased competition in the Indian Banking industry has driven the interest yields and

consequently, the NIMs, southwards. Hence, banks are increasingly concentrating on non-

interest income to shore up profits. In FY2003, the range of non-interest income for Indian

banks (as percentage of average Total Assets) was between 1.01 and 3.00%. The median for

Indian banks showed a moderate increase from 1.63% in 2002 to 1.77% in 2003. The non-

interest income (as percentage of Average Total assets) of the global benchmark banks varied

from 0.72 to 3.13% (with a median value of 1.62%), or the year ended December 31, 2002. The

decline in interest rates in India over the last few years has helped Indian banks book

substantial profits from the sale of investments, thus boosting their Non-Interest Income. As the

high profits accruing from the sale of investments are not lively to be sustainable, ICRA has

23

benchmarked the pure fee based income (i.e. looking at Non-interest income without profits

from sale of investments) as a percentage of average total income. 16 of the 21 Indian banks in

the study had a fee based income ratio of between 0.4 and 0.8%.A comparison after similar

adjustment for the global benchmark banks reveals that the fee-based income ratio of Indian

banks is lower.

• Operating Expense Ratio

The Operating Expense Ratio (operating expenses as a ratio of the average total assets)

reveals how expensive it is for a bank to maintain its fixed assets and human capital that are

used to generate that income streams, The median Operating Expense ratio for Indian banks

was 2.26% in 2003, which is comparable with that for the global benchmark banks (2.09%).

1.7 Asset Quality Benchmarking

• Gross NPAs

The median Gross NIA ratio (Gross NPA as a proportion of total advances) for Indian banks

was 9.40% for FY2003 and 10.66% for FY2002. The values of the Gross NPA ratio for FY 2003

range between 2.26 and 14.68%.Many global banks do not disclose their Gross NPA

percentages in their annual reports.

• Net NPAs

The median Net NPA ratio ("Net NPA as a proportion of Net advances) of Indian banks was

4.33% for FY2003 and 5.39% for FY2002. The values of Net NPA ratio for FY 2003 for the

global benchmark banks ranged between 0.37 and 7.08%. Most of the global benchmark banks

do not disclose their Net NPA ratios in their annual reports. From the study it can be inferred

that the median Net NPA percentage for Indian banks is marginally higher than that for the

global benchmark banks.

• Efficiency Benchmarking

ICRA studied the following parameters to assess the efficiency of Indian banks vis-à-vis their

foreign counterparts:

• Profitability per employee

• Profitability per branch

24

• Business per employee

• Business per branch

• Expenses per employee

• Expenses per branch

The business model of the global benchmark banks involves outsourcing of non-core activities.

In the case of Indian banks, particularly those in the public sector, both non-core and core

business functions are carried out in-house. The global benchmark banks display higher

efficiency parameters, mainly because of the outsourcing model.

Thus, the efficiency parameters are not strictly comparable, as they are affected by the business

plans of specific banks and also by economy-specific considerations.

ICRA has presented the analysis of the performance of Indian and international banks in the

following sections. We would like to highlight that several factors influence the results here, and

caution needs to be exercised in arriving at inferences. E.g. comparing expenses per branch (or

employee) for banks across different economies involves conversion of amounts to a common

currency. The results depend on the conversion rates of foreign exchange used (e.g. USD per

rupee or Euro per rupee). In this report, ICRA has used nominal rates of foreign currencies

rather than rates based on PPP (Purchasing Power Parity). On another dimension, Indian banks

and international banks operate under different business models and levels of technology.

Increasingly, sophisticated banks (particularly in advanced countries) use several channels to

transact business with customers, such as, the Internet, telephone, debit cards, and ATMs.

Therefore, results from benchmarking using parameters such as business per branch or

expenses per branch (which are appropriate parameters to compare across banks that operate

predominantly through branches) need to be appropriately interpreted in an exercise when we

compare heterogeneous banks across different economies.

Profitability per Employee

The profit per employee figure for 17 out of the 21 Indian banks was in the range of Rs. 0.02

crore for the financial year ended March 2003. Most Indian banks posted higher profits per

employee in FY2003 as compared with FY2002. This overall trend of increasing employee

profitability may be attributed to the reduction in the number of employees following the launch

of Voluntary Retirement Schemes (VRS) by some banks as well as higher profits by the banks.

25

On an average, new private sector banks enjoy a higher increase in profitability per employee,

as compared with their public sector counterparts. This may be attributed largely to the better

technology that the new private sector banks employ, besides the advantage of carrying no

historical baggage. As for the global benchmark banks, the profitability per employee for HSBC

was robust at USD 0.12 million (Rs. 0.552 crore) for FY 2002. For ABN AMRO Bank, the figure

was EUR 0.02 million (Rs.l crore). On an intertemporal basis, the profitability per employee for

the global benchmark bank also showed growth.

• Profitability per Branch

For most Indian banks, the profit, per branch was in the range of Rs. 0-0.2 crore. However, the

new private sector banks displayed the highest profits per branch, at Rs. 1.73 and 1.22 crore for

the years 2003 and 2002, respectively. On an inter-temporal basis, profit per branch has been

increasing gradually in the Indian banking sector. The growth in profit per branch for Indian

banks is attributable to the overall increase in profitability in the banking industry. In the case of

the foreign peer group, profitability per branch shows a small increase over the period covered

by this study. As for the global benchmark banks, profitability per branch for Bank of America is

at a robust USD 1.62 million (Rs. 7.44 crore), while the figure for ABN AMRO Bank is EUR 0.87

million (Rs. 4.36 crore) for the FY 2002. Hence, profitability per branch for the global benchmark

banks is higher than that of Indian banks.

• Business per Employee

Since different employees in a bank contribute in different ways to the revenues and profits of a

bank, it is difficult to come up with one universal metric that captures the business per employee

accurately. For' this analysis, ICRA has used the amount of deposits mobilised per employee as

a measure of the business per employee. The Indian banking industry on an average mobilised

Rs. 1-2 crore of deposits per employee for the year ended March 2003. In this respect, private

sector banks lead the group of Indian banks. The top bank in this category showed a deposit

per employee of Rs. 7.14 crore for the year ended March 2003. As for the global benchmark

banks, business per employee for HSBC was robust at USD9.71 million (Rs. 44.66 crore), while

that for ABN AMRO Bank was EUR 4 million (Rs. 20 crore) for the year ending December 2002.

Thus, deposit mobilisation per employee for the global benchmark banks is higher than that of

Indian banks.

26

• Business per Branch

On an average, the banks showed a deposit of around Rs. 10-30 crore per branch for the year

ended March 2003. In recent times, the deposit mobilisation for Indian Banks on a branch basis

has witnessed a steady increase. The new private sector banks in India have led the way in this

regard, because of the better use of technology. The highest deposit per branch stood at Rs.

103.24 crore in 2003 for a new private sector bank, as compared with Rs. 68.71 crore in 2002.

The global benchmark banks mobilised more business per branch as compared with their Indian

counterparts. Bank of America mobilised USD 88.9 million (Rs. 408.94 crores) for the financial

year ended 2002, while ABN AMRO Bank mobilised EUR 140 million (Rs. 700 crores). The

higher per-bank deposit mobilisation for the global benchmark banks may be attributed to their

superior technology orientation and the higher gross domestic products (GDP) of their

respective countries. 3.5.5 Expenses per Employee.

For this analysis, ICRA has used the employee expenses per employee as a measure of the

expenses per employee. Indian banks, on an average, expensed Rs. 0.025 crore per employee

in FY2002. For the new private sector banks, this figure was higher. The highest expense per

employee incurred by an Indian bank for the year 2002 was Rs. 0.041 crore per employee.

In the case of the global benchmark banks, the expenses per employee for City Group Inc.

was at USD 0.08 million (Rs. 0.36 crore), while for ABN AMRO Bank it was EUR 0.07 million

Rs. 0.36 crore).

• Expenses per Branch

For this analysis, ICRA has used operating expenses per branch as a measure of the expenses

per branch. The expense per branch for most Indian banks was Rs. 0.56 crore for FY2002.

Over the years, Indian banks have reported a gradual increase in such expenses, with

competition-prompted upgrade being the primary reason for the same. In the case of the global

benchmark banks, expense per branch for Bank of America was USD 4.93 million (amount in

Rs. 22.68 crore), while for ABN AMRO Bank it was EUR 4.6 million (Rs. 22.99 crore).

1.8 Structural Benchmarking

Since its inception in 1980s) BIS has issued several guidance notes for banks and bank

supervisors. These notes have sought to improve the integrity of the global banking system and

propagate best practices in banking across the world. For issues related to accounting, BIS has

27

relied on the International Accounting Standards (IAS) issued by the International Accounting

Standards Committee (IASC). Banks are supposed to follow these accounting standards as part

of best practices. For the structural benchmarking study of the Indian banking sector, ICRA has

used primarily the guidance notes issued by BIS and the relevant IAS as the benchmarks of

best practices. ICRA has also referred to standards as mentioned under, US and UK. GAAP

(Generally Accepted Accounting Practices) where they provide a good understanding of

international best practices.

• Capital Adequacy Norms for Banks

BIS introduced capital adequacy norms for banks for the first time in 1988. To improve on the

existing norms, BIS issued a Consultative Document in January 2001, proposing changes to the

existing framework. The objective of this document is to develop a consensus on the Basel II

Accord (as it is popularly known), which is expected to be implemented in 2007. Based on

feedback received from various quarters, BIS issued a new Consultative Document in April

2003. In this document, BIS has proposed the following key changes over the existing norms:

• Introduction (of finer grades of risk weighting in corporate credit:

According to the original 1988 Accord, all credit risks have a 100% per cent weighting. Under

the new method, grades of weightings in the 20-150% range will be assigned.

• Introduction of charges for operational risks:

Under the proposed Basel II Accord, banks have to allocate capital for operational risks. BIS

has suggested three methods for estimating operational risk capitals:

1. Basic Approach,

2. Standardised Approach, and

3. Advanced Measurement Approach.

• Capital requirement for mortgages reduced:

The risk weights on residential mortgages will be reduced to 35% from 50%. During the 1990s,

the RBI adopted the strategy of attaining a Capital Adequacy Ratio (CAR) of 8% in a phased

manner. Subsequently, in line with the recommendations of the Committee on Banking Sector

Reforms, the minimum CAR was further raised to 9%, effective 31st March 2000.

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As a step towards implementing the Basel II guidelines, the RBI in its circular of 14th May, 2003

has proposed new methods for estimating regulatory risk capital. To estimate the impact of the

proposed changes on the capital adequacy position of Indian banks, the RBI has asked select

banks to estimate their risk weighted assets on the basis of the new method. As per this, the

RBI has asked for the estimation of capital requirement on the basis of the external credit rating

of borrowers. For nonrated borrowers, the RBI has asked the select banks to use the existing

100% risk weights.

The RBI has also asked the banks to calculate operational risk capital separately following the

Basel approach. Based on the result of the exercise, the RBI will issue new guidelines on

estimating economic capital. Additionally, the RBI has asked banks to introduce internal risk

scoring models. It is expected that once the Basel II Accord is signed, the RBI will allow banks

to move to the IRB approach. The Capital Adequacy norms in India are in line with the best

practices as suggested by BIS. Once the Basel II Accord is implemented, the method of

estimation of risk capital will undergo a significant change. RBI has already taken appropriate

steps to prepare the Indian banking industry for such changes.

Recognition of Financial Assets & Liabilities

IAS 39 requires that all financial assets and all financial liabilities be recognised on the balance

sheet. This includes all derivatives. Historically, in many parts of the world, derivatives have not

been recognised as liabilities or assets on balance sheets. The argument for this practice has

been that at the time the derivative contract was entered into, no cash or other asset was paid.

The zero cost justified non-recognition, notwithstanding the fact that as time pauses and the

value of the underlying variable (rate, price, or index) changes, the derivative has a positive

(asset) or negative (liability) value.

In India, derivatives are still off-balance sheet items and considered part of contingent liabilities.

So in Indian treatment of derivatives is different from International Accounting Standards.

• Valuation of Financial Assets

IAS 39 has classified financial assets under four categories. The following table summarises the

classification and measurement scheme for financial assets under IAS 39, Under US GAAP,

marketable equity securities and debt securities are classified as under:

29

• trading,

• Available for sale, or

• held to maturity.

• Recognition of Non-Performing Assets (NPAs)/Impaired Assets

Under IAS 39, impairment recognition is left to management discretion (its perception of the

likelihood of recovery). Impairment calculation compares the carrying amount of the financial

asset with the present value of the currently estimated amounts and timings of payments. If the

present value is lower than. The carrying amount, the loan is classified as NPL.

Under US GAAP, loans assume non-accrual statuses if any of the following conditions are

fulfilled:

Full repayment of principal or interest is in doubt (in management's judgment), or if scheduled

principal or interest payment is past due 90 days or more, and if the collateral is insufficient to

cover the principal and interest.

In India, NPAs are classified under three categories-Sub-standard, Doubtful and Loss on the

basis of the number of months the amount is overdue for. India proposed to move from 180

days to a 90-day past due classification rule for NPA recognition effective March 2004.

The financial instrument's original effective interest rate is the rate to be used for discounting.

Any impairment loss is charged to profit and loss account for the period. Impairment or

"uncollectability" must be evaluated individually for material financial assets. A portfolio

approach may be used for items that are individually small [IAS 39.109]. Therefore, under IAS,

provisioning is based on management discretion. Provision in excess of expected loan losses

may be booked directly to shareholders' equity. As with IAS, under the UK, And US GAAP also,

provisioning is based on management discretion. Under US GAAP, when the Net Present Value

of a loan is less than the carrying value, the difference is booked as provision.

In India; provisioning norms are more explicit than they are under the IAS. RBI has specified

norms for various classes of NPL as follows:

Standard Assets: 10%

Doubtful Assets: 100% of unsecured portion,

30

20-50% on secured portion

Loss Assets: 100% Interest Accrual on M on-performing Loans / impaired Assets

Interest Accrual on M on-performing Loans / impaired Assets

Under both IAS and US GAAP, there is no specific prescription for interest accrual on NPAs.

Under UK. GAAP, interest is suspended upon classification as NPL. However, suspension may

be deferred up to 12 months if sufficient collateral exists.

According to Sound Practices for Loan Accounting and Disclosure (1999) number 11, the BIS

Committee on Banking Supervision recommends that when a loan is identified as impaired, a

bank should cease accruing interest in accordance with the terms of the contract. Interest on

impaired loans should not contribute to net income if doubts exist over the collectability of loan

interest or principal.

In India, accrual of interest is suspended upon classification of a loan as non performing.

• General Provisioning on Performing Loans

Under IAS, UK and US GAAP, there is no specific prescription for general provisioning towards

performing loans. However, Indian banks have a provisioning require; f tent of 0.2 5% on all

standard assets.

• Conclusion

The RBI norms for classification of assets, and provisioning against, bad/doubtful debts are

more detailed and precise vis-a-vis international rules. While the international norms often leave

bad debt provision levels to "management discretion", Indian standards are precise and clearly

state exactly when and by how much reported earnings must be charged off for bad debts.

In India, detailed accounting standards for derivatives are yet to be introduced. As of now,

derivatives continue to be considered as off-balance sheet liabilities.

1.9 Likely Future Trends and their Implications for Indian Banks

• Financial Disintermediation and Bank Profitability

The degree of banking disintermediation and financial sophistication are important factors in the

development of a country's economy. Disintermediation affects the allocation process for both

31

savings and credits in the economy. With the introduction of sophisticated deposit products by

mutual funds, pension funds and insurance companies, individual and corporate depositors now

have more options for savings. A similar trend is also visible in credit offerings. More and more

corporate entities are now approaching the capital market to raise funds either in the form of

debt or equity. At the end of the 1990s, the US banking industry was facing a high level of

disintermediation, as most outstanding savings were in mutual funds, pension funds, and life

insurance plans, but not in bank deposits or other liability products. However, in continental

Europe, most banking systems (as in Germany, Spain, Italy, Austria, France, etc.) are still highly

bank-intermediated, although the trend is clearly towards faster disintermediation for both

savings and credits. In India, financial disintermediation is likely to catch up with banks sooner

than later. With the opening up of the financial sector, Indian banks are facing competition from

the mutual fund and insurance sectors for savings. On the credit side, good quality borrowers

have started raising debt directly from the market at competitive rates.

• Changing Capital Adequacy Norms

Capital adequacy norms for banks are likely to undergo a change after the Basel II Accord is

implemented. In the current system, Indian banks need to allocate 9% capital, irrespective of the

credit quality of a borrower. In the new system, a bank offering credit to a better quality

corporate entity is likely to require less regulatory capital. The allocation of regulatory capital on

the basis of credit quality would encourage banks to estimate their Risk adjusted Return on

Capital (RAROC) rather than compute simple margins. Similarly, banks now need to distinguish

between the credit qualities of sovereign borrowings and inter-bank borrowing, as they would

need to allocate capital to sovereign credit and inter-bank credit on the basis of external ratings,

or using the IRB approach.

To emerge successful in the Basel II regulatory environment, banks would need to introduce the

practice of risk-based pricing of loans, which in turn would require a bank to implement advance

Risk Management Systems. To implement such systems, banks would need to implement the

following key steps:

• Develop Credit Risk Scoring Models

• Generate Probability of Default (PD) associated with each risk grade

• Estimate Loss Given Default (LGD) for each collateral type.

32

• Calculate expected and unexpected loss in a portfolio based on correlation amongst loans.

• Compute the capital that would be required to be held against economic loss potential of the

portfolio.

Similarly, banks would have to introduce robust systems for measuring and controlling Market

Risk and Operations Risk. .3 Management of Non-Performing Assets The size of the NPA

portfolio in the Indian banking industry is close to Rs. 1,00,000 crore, which is around 6% of

India's GDP. NPAs affect banks profitability on two counts:

The introduction of scientific credit risk management systems would lower slippage of assets

from the performing to the nonperforming category. Further, banks with better NPA recovery

processes would be able to reduce their provisioning requirements, thereby increasing their

profitability. To enable a fair borrower-lender relationship in credit, the Government of India has

recently enacted the Securitisation and Reconstruction of Financial Assets and Enforcement of

Security interest Act 2002 (SRES Act). Due to several cases still to be resolved in courts of law,

it is. Not clear as yet, how far this Act is set to alter the NPA recovery scenario in India.

Following the announcement of the RBI's Asset Classification norms, the process of Asset

Quality Management involves segregating the total portfolio into three segments and having

detailed strategies for each. The three segments are:

• Standard/Performing Assets

• Special Mention Accounts/Sub-Standard Assets

• Chronic Non-Performing Assets

Banks need to vigilantly monitor Standard Assets to arrest any account slippage into the non-

performing grade. Besides, banks need to churn their credit portfolio so as to maximise returns

while keeping the risks pegged at acceptable levels.

Special Mention Accounts are assets with potential weaknesses which deserve close attention

and timely remedial action. The typical warning signs exhibited by a borrower ranges from

frequent excesses in the account to non-submission of periodical statements. Account

restructuring and rehabilitation tools are best implemented during this stage. However, the

challenges faced while restructuring include, (a) selecting the genre of assets to be restructured,

33

(b) quantifying the benefits to be extended, (c) determining repayment schedules, and (d)

coordinating and balancing the needs of several lenders.

Chronic Non-Performing Assets can now be better managed following the enactment of the

SIZES Act. The Act provides the requisite regulatory framework for the foreclosure of assets by

lenders, incorporation of Asset Reconstruction Companies (ARCS), and formation of a Central

Registry. In the wake of this new legislation, amicable solutions may be realised for Chronic

NPAs. The strategies include Enforcement of Security Interest, Securitisalion, One-Time

Settlement (OTS), and Write-off. However, a scientific approach to deciding which of these

alternative routes must be taken hinges on: (a) assessment in terms of quality of the underlying

assets and their realisable value, (b) alternative use of the assets, and (c) willingness of the

borrower to settle outstanding dues.

• Conclusion

The profitability of Indian banks in recent years compares well with that of the global benchmark

banks primarily because of the higher share of profit on the sale of investments, higher leverage

and higher net interest margins of Indian banks. However, many of these drivers of higher

profits of Indian banks may not be sustainable. To ensure long-term profitability, Indian banks

need to focus on the following parameters and build systemic capability in management of the

same:

• Ensure that loans are diversified across several customer segments

• Introduce robust risk scoring techniques to ensure better quality of loans, as well as to enable

better risk-adjusted returns at the portfolio level

• Improve the quality of credit monitoring systems so that slippage in asset quality is minimised

• Raise the share of non-fund income by increasing product offerings wherever necessary by

better use of technology

• Reduce operating expenses by upgrading banking technology, and

• Improve the management of market risks

• Reduce the impact of operational risks by putting in place appropriate frameworks to measure

risks, mitigate them or insuring them.

34

The RBI as the regulator of the Indian banking industry has shown the way in strengthening the

system, and the individual banks have responded in good measure in orienting them selves

towards global best practices.

MAJOR DEVELOPMENTS IN BANKING AND FINANCE

• Banking Developments

The RBI allowed resident Indians to maintain foreign currency accounts. The accounts to be

known as resident foreign currency (domestic) accounts, can be used to park forex received

while visiting any place abroad by way of payment for services, or money received from any

person not resident in India, or who is on a visit to India, in settlement of any lawful obligations.

These accounts will be maintained in the form of current accounts with a cheque facility and no

interest is paid on these accounts. With a view to liberalise gold trading, the Reserve Bank has

decided to permit authorised banks to enter into forward contracts with their constituents like

exporters of gold products, jewellery manufacturers and trading houses, in respect of the sale,

purchase and loan transactions in gold with them. The tenor of such contracts should not

exceed 6 months. The Reserve Bank of India has told foreign banks not to shut down branches

without informing the central bank well in advance. Foreign banks have been further advised by

the Reserve Bank of India to furnish a detailed plan of closure to ensure that their customers’

interests and conveniences are addressed properly.

The RBI has prohibited urban co-operative banks from acting as agents or sub-agents of money

transfer service schemes. The RBI has allowed banks to invest undeployed foreign currency

non-resident (FCNR-B) funds in the overseas markets in the long-term fixed income securities

with ratings a notch lower than highest safety. Earlier, banks were allowed to invest only in long-

term securities with highest safety ratings by international agencies.

The RBI has defined the term “wilful defaulter” paving the way for banks to acquire assets of

defaulting companies through the Securitisation Ordinance and reduce their NPAs faster.

According to the RBI a wilful defaulter is one who has not used bank funds for the purpose for

which it was taken and who has not repaid loans despite having adequate liquidity.

International credit rating agency Standard & Poor has estimated that the level of gross

problematic assets in India can move into the 35-70 per cent range in the event of a recession.

It has also estimated that the level of non-performing assets (NPAs) in the system to be at 25

per cent, of which only 30 per cent can be recovered.

35

The Reserve Bank of India has decided to extend operation of the guidelines for the one time

settlement scheme for loans up to Rs.50,000 to small and marginal farmers by public sector

banks for another 3 months, i.e., up to March 31, 2003.

The Reserve Bank of India, as part of its policy of deregulating interest rates on rupee export

credit, has freed interest rates on the second slab - 181 to 270 days for pre-shipment credit and

91 to 180 days for post-shipment credit with effect from May 1, 2003.

The Cabinet cleared a financial package for IDBI and agreed to take over the contingent

liabilities to the tune of Rs.2500 crore over five years. The IDBI Act will be repealed during the

winter session of the Parliament, paving the way for IDBI’s conversion into a banking company.

The IDBI would be given access to retail deposits, to enable it to bring down the cost of funds,

but will be spared from priority sector lending and SLR requirements for existing liabilities.

The RBI has issued guidelines for setting up of offshore banking units (OBUs) within special

economic zones (SEZs) in various parts of the country. Minimum investment of $10 million is

required for setting up an OBU. All commercial banks are allowed to set up one OBU each.

OBUs have to undertake wholesale banking operations and should deal only in foreign

currency. Deposits of the OBUs will not be covered by deposit insurance. The loans and

advances of OBUs would not be reckoned as net bank credit for computing priority sector

lending obligations. The OBUs will be regulated and supervised by the exchange control

department of the RBI.

With a view to develop the derivatives market in India and making available hedged currency

exposures to residents an RBI Committee headed by Smt. Grace Koshie, recommended

phased introduction of foreign currency-rupee (FC/NR) options. The Reserve Bank of India has

notified the draft scheme for merging Nedungadi Bank with Punjab National Bank. This is the

first formal step towards bringing about a merger between the two Banks.

The Reserve Bank of India has agreed to allow capital hedging for foreign banks in India. The

guidelines pertaining to capital hedging will be issued by RBI soon.

The Reserve Bank of India has decided to allow foreign institutional investors (FIIs) to enter into

a forward contract with the rupee as one of the currencies, with an authorised dealer (AD) in

India to hedge their entire exposure in equities at a particular point of time without any reference

to the cut-off date. Further, the RBI has also increased Authorised Dealer’s overseas market

36

investment limit to 50 per cent of their unimpaired tier-I capital or $ 25 million, whichever is

higher.

Reserve Bank of India doubled the foreign exchange available under the basic travel quota

(BTQ) to resident individuals from US $5000 to US $10000, or its equivalent. The Government

has decided to dispose of UTI Bank as part of restructuring Unit Trust of India. Though the

details in this regard are yet to be worked out, it has been decided that the bank will be

disposed of during the course of the restructuring.

The RBI has allowed tour operators to sell tickets issued by overseas travel operators such as

Eurorail and other rail/road and water transport operators in India, in rupees, without deducting

the payment from the travellers’ basic travel quota.

The Reserve Bank of India (RBI) has banned banks from offering swaps involving leveraged

structures, which can cause huge losses if the market moves the other way.

The RBI constituted committee on payment system has recommended that the central bank, as

the regulator of payment and settlement systems, should be empowered to regulate non-

banking systems.

• Market Developments and New Products

The Hong Kong and Shanghai Banking Corporation will be bringing $150 million additional

capital to India in the current fiscal.

The Reserve Bank of India has ordered a moratorium on the Nedungadi Bank. The moratorium

effective from the close of business will be in force up to February 1, 2003. During this period,

the central bank is likely to finalise the plans for merging Nedungadi Bank with Punjab National

Bank.

ABN Amro Bank launched its Business Process outsourcing (BPO) operations, ABN Amro

Central Enterprise Services (ACES) in Mumbai. It has been set up with an initial investment of 4

million euros (Rs.19 crore) and has been capacitised at 650 seats in a single shift.

The Canara Bank has returned 48 per cent (Rs. 277.87 crore) of its capital to the Government

before its Initial Public Offer.

China has granted licence to Bank of India to open a representative office in the south Chinese

city of Shenzhen.

37

Shri A.K. Purwar is appointed as the Chairman of State Bank of India. The State Bank of India

has launched “SBI Cash Plus”, its Maestro debit card for which it has tied up with Master Card

International. SBI Cash Plus will allow customers to access their deposit accounts from ATMs

and merchant establishments.

The Siam Commercial Bank, having Thailand government as the major share holder, is

planning to close down its banking operations in India from November 30, 2002, as part of its

global restructuring strategy.

The Punjab National Bank (PNB) has got license from the Reserve Bank of India for doing

internet banking. The bank is likely to do the formal launch of its internet banking solution within

a few weeks time.

The ICICI Bank is planning to set up kiosks to offer financial services in the rural areas. This

outfit would also extend agricultural loans.

38

CLASSIFICATION OF SCHEDULED BANKING

STRUCTURE IN INDIA

The scheduled banks are divided into scheduled commercial banks and scheduled co operative

banks. Further scheduled commercial banks divided into the Public Sector Banks, private sector

banks, foreign banks, and regional rural banks. Whereas scheduled co-operative banks are

classified into scheduled urban co operative and scheduled state co- operative.RBI has further

classified public sector banks into nationalized banks, state bank of India and its subsidiaries.

And private banks have been classified into old and new private sector banks. As far as the

number is concerned, total public sector banks are 27, private sector banks are 30, foreign

banks are 36, and regional rural banks are 196. Thus in scheduled commercial bans, the

regional rural banks are on the top number. In the scheduled co-operative banks, there are 57

scheduled cooperatives and 16 scheduled co-operative banks. Today the overall commercial

banking system in India may be distinguished into:

39

Schedule commercial banks Schedule co-operative banks

Public

sector bank

(27)

Private

sectors

banks(30)

Foreign

banks in

India(36)

Regional

Rural banks

in India(196)

Schedule Urban

bank co-operative

banks (57)

Schedule state co-

operative banks

(16)Nationaliz

ed

Bank(19)

SBI & its

Subsidiari

es(8)

SCHEDULE BANKS IN INDIA

Old private sector bank (21)

New private sector bank (9)

1. Public Sector Banks

2. Private Sector Banks

3. Co-operative Sector Banks

4. Development Banks

PUBLIC SECTOR BANKS

a. State Bank of India and its associate banks called the State Bank group

b. 20 nationalized banks

c. Regional Rural Banks mainly sponsored by Public Sector Banks

PRIVATE SECTOR BANKS

a. Old generation private banks

b. New generation private banks

c. Foreign banks in India

d. Scheduled Co-operative Banks

e. Non-scheduled Banks

CO-OPERATIVE SECTOR

The co-operative banking sector has been developed in the country to the supplement the

village money lender. The co-operative banking sector in India is divided into 4 components

1. State Co-operative Banks

2. Central Co-operative Banks

3. Primary Agriculture Credit Societies

4. Land Development Banks

5. Urban Co-operative Banks

6. Primary Agricultural Development Banks

40

7. Primary Land Development Banks

8. State Land Development Banks

DEVELOPMENT BANKS

1. Industrial Finance Corporation of India (IFCI)

2. Industrial Development Bank of India (IDBI)

3. Industrial Credit and Investment Corporation of India (ICICI)

4. Industrial Investment Bank of India (IIBI)

5. Small Industries Development Bank of India (SIDBI)

6. SCICI Ltd.

7. National Bank for Agriculture and Rural Development (NABARD)

8. Export Import Bank of India

9. National Housing Bank

PUBLIC SECTOR BANKS

Before the independence, the banking system in India was primarily associated with urban

sector. After independence, the banks had to spread out into rural and un-banked areas and

make credit available to the people of those areas. In 1969 the government nationalized 14

major commercial banks. Still the wide disparities continued. To reduce the disparities the

government nationalized 6 more commercial banks in 1980 government came to own 28 banks

including SBI and its 7 subsidiaries. Today, we are having a fairly well developed banking

system with different classes of banks-public sector banks, foreign banks, and private sector

banks-both old and new generation.

In July 1993, New Bank of India was merged with Punjab National Bank. Now, there are 27

banks in the public sector viz. State Bank of India and its 7 associates, 19 commercial banks

exclusive of Regional Rural. In terms of sheer geographical spread, the public sector system is

the largest. The statistics are as follows: a network of 64000, branches-one branch for every

14000 Indian with over 64 crores customers. This labour intensive network has built-in cost,

41

which makes the public sector banks inherently uncompetitive. Reduction of branches to

achieve cost saving has not received a munch thrust as it should. Public sector banks are

characterized by mammoth branch network, huge work force, relatively lesser mechanization,

and huge volume but of less value business transactions, social objectives and their own legacy

system and procedures. “Improving profitability in general requires efforts in several

directions,i.e. cutting in cost, improving productivity, better recovery of loan and to reduce high

level of NPAs”.The public sector banks have to build up the cost-benefit culture in their

operations. When there is a thin margin in banking operation, the public sector banks in India

have to increase the turnover. Previously, Indian banks were relying on high credit deposit ratio.

Now, the Indian banks have to depend on the volume of high business turnover. The returns on

assets have to be improved.

Further, the PSBs in Indian have to compare them with the highly profitable bank with regards

to operating expenses. They have to ensure that each every account is profitable and product

should be such, while generates more profit.

CHALLENGES FOR THE PUBLIC SECTOR

Indian banks functionally diverse and geographically widespread have played a crucial role in

the socio-economic progress of the country after independence. Growth of large number of

medium and big industries and entrepreneurs in diverse fields were the direct results of the

expansion of activities of banks. The rapid growth, forever lead to strains in the operational

efficiency of the banks and the accumulation of non-performing assets (NPAs) in their loans

portfolio. The uncomfortably high level of NPAs of banks however is a cause for worry and it

should be brought down to international acceptable levels for creating a vibrant and competitive

financial system. NPAs are serious strains on the profitability of the banks as they cannot book

income on such accounts and their funding cost provision requirement is a charge on their

profit. Although S & P cited as a reasons for mounting of NPAs priority sector lending, outdated

legal system which not only encourages the incidence of NPAs but also prolongs their existence

by placing a premium on default and delay in finalization of rehabilitation packages by the Board

for Industrial and Financial Reconstruction are some of the major causes for the rising of NPAs.

The following deficiencies were noticed in the managing Credit Risk:

The absence of written policies.

42

The absence of portfolio concentration limits.

Excessive centralization or decentralization of lending authorities.

Cursory financial analysis of borrower.

Infrequent customer contact.

Inadequate checks and balances in credit process

The absence of loan supervision

A failure to improve collateral position as a credit deteriorate

Excessive overdraft lending.

Incomplete credit files

The absence of the assets classification and loan-loss provisioning standards

A failure to control and audit the credit process effectively.

In July 1993, New Bank of India was merged with Punjab National Bank. Now, there are 27

banks in the public sector viz. State Bank of India and its 7 associates, 19 commercial banks

exclusive of Regional Rural. Following are the 21 public sector banks.

1. Allahabad Bank

2. Andhra Bank

3. Bank of Baroda

4. Bank of India

5. Bank of Maharashtra

6. Canara Bank

7. Central Bank of India

8. Corporation Bank

9. Dena Bank

43

10. Indian Bank

11. Indian Overseas bank

12. Punjab National Bank

13. Punjab and Sind Bank

14. State Bank of India

15. State Bank of India & its associates.

1) State Bank of Hyderabad

2) State Bank of India

3) State Bank of Indore

4) State Bank of Mysore

5) State Bank of Saurashtra

6) State Bank of Travancore

18. Syndicate Bank

19. UCO Bank

20. Union Bank of India (UBI

21. Vijaya Bank

44

NON PERFORMING ASSETS

NPA. The three letters Strike terror in banking sector and business circle today. NPA is short

form of “Non Performing Asset”. The dreaded NPA rule says simply this: when interest or other

due to a bank remains unpaid for more than 90 days, the entire bank loan automatically turns a

non performing asset. The recovery of loan has always been problem for banks and financial

institution. To come out of these first we need to think is it possible to avoid NPA, no cannot be

then left is to look after the factor responsible for it and managing those factors.

Definitions:

An asset, including a leased asset, becomes non-performing when it ceases to generate

income for the bank. A ‘non-performing asset’ (NPA) was defined as a credit facility in respect of

which the interest and/ or instalment of principal has remained ‘past due’ for a specified period

of time.

With a view to moving towards international best practices and to ensure greater transparency,

it has been decided to adopt the ‘90 days’ overdue’ norm for identification of NPAs, from the

year ending March 31, 2004. Accordingly, with effect from March 31, 2004, a non-performing

asset (NPA) shall be a loan or an advance where;

Interest and/ or installment of principal remain overdue for a period of more than 90 days in

respect of a term loan,

The account remains ‘out of order’ for a period of more than 90 days, in respect of an

Overdraft/Cash Credit (OD/CC), The bill remains overdue for a period of more than 90 days in

the case of bills purchased and discounted,

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 purposes.

As a facilitating measure for smooth transition to 90 days norm, banks have been advised to

move over to charging of interest at monthly rests, by April 1, 2002. However, the date of

classification of an advance as NPA should not be changed on account of charging of interest at

monthly rests. Banks if the interest charged during any quarter is not serviced fully within 180

45

days from the end of the quarter with effect from April 1, 2002 and 90 days from the end of the

quarter with effect from March 31, 2004.

MEANING OF NPAS

An asset is classified as non-performing asset (NPAs) if the borrower does not pay dues in the

form of principal and interest for a period of 180 days. However with effect from March 2004,

default status would be given to a borrower if dues were not paid for 90 days. If any advance or

credit facilities granted by bank to a borrower become non-performing, then the bank will have

to treat all the advances/credit facilities granted to that borrower as non-performing without

having any regard to the fact that there may still exist certain advances / credit facilities having

performing status.

CLASSIFICATION OF LOANS

In India the bank loans are classified on the following basis.

Performing Assets:

Loans where the interest and/or principal are not overdue beyond 180 days at the end of the

financial year.

Non-Performing Assets:

Any loan repayment, which is overdue beyond 180 days or two quarters, is considered as NPA.

According to the securitisation and reconstruction of financial assets and enforcement of

security interest ordinance, 2002 “non-performing asset”(NPA) means “an asset or account of a

borrower, which has been classified by a bank or financial institution as sub-standard, doubtful

or loss asset, in accordance with the directions or guidelines relating to asset classifications

issued by the Reserve Bank” Internationally, income from non-performing assets is not

recognized on accrual basis, but is taken into account as income only when it is actually

received. It has been decided to adopt similar practice in our country also. Banks have been

advised that they should not charge and take to income account the interest on all Non-

performing assets. An asset becomes non-performing for a bank when it ceases to generate

income.

NPAs: AN ISSUE FOR BANKS AND FIs IN INDIA

46

To start with, performance in terms of profitability is a benchmark for any business enterprise

including the banking industry. However, increasing NPAs have a direct impact on banks

profitability as legally banks are not allowed to book income on such accounts and at the

sometime are forced to make provision on such assets as per the Reserve Bank of India (RBI)

guidelines. Also, with increasing deposits made by the public in the banking system, the banking

industry cannot afford defaults by borrower s since NPAs affects the repayment capacity of

banks. Further, Reserve Bank of India (RBI) successfully creates excess liquidity in the system

through various rate cuts and banks fail to utilize this benefit to its advantage due to the tear of

burgeoning non-performing assets.

INDIAN ECONOMY AND NPAs

Undoubtedly the world economy has slowed down, recession is at its peak, globally stock

markets have tumbled and business itself is getting hard to do. The Indian economy has been

much affected due to high fiscal deficit, poor infrastructure facilities, sticky legal system, cutting

of exposures to emerging markets by FIs, etc.

Further, international rating agencies like, Standard & Poor have lowered India’s credit rating to

sub-investment grade. Such negative aspects have often outweighed positives such as

increasing forex reserves and a manageable inflation rate. Under such a situation, it goes

without saying that banks are no exception and are bound to face the heat of a global downturn.

One would be surprised to know that the banks and financial institution in India hold

nonperforming assets worth Rs. 110000 crores Bankers have realized that unless the level of

NPAs is reduced drastically, they will find it difficult to survive.

GLOBAL DEVELOPMENTS AND NPAs

The core banking business is of mobilizing the deposits and utilizing it for lending to industry.

Lending business is generally encouraged because it has the effect of funds being transferred

from the system to productive purposes, which results into economic growth. Failure of borrower

to fulfil its contractual obligations either during the course of a transaction or on a future

obligation.

A question that arises is how much risk can a bank afford to take? Recent happenings in the

business world -Enron, WorldCom, Xerox, Global Crossing do not give much confidence

to banks. In case after case, these giant corporate becan1e bankrupt and failed to provide

investors with clearer and more complete information thereby introducing a degree of risk that

47

many investors could neither anticipate nor welcome. The history of financial institutions also

reveals the fact that the biggest banking failures were due to credit risk. Due to this, banks are

restricting their lending operations to secured avenues only with adequate collateral on which to

fall back upon in a situation of default.

FACTORS FOR RISE IN NPAs

The banking sector has been facing the serious problems of the rising NPAs. But the problem

of NPAs is more in public sector banks when compared to private sector banks and foreign

banks. The NPAs in PSB are growing due to external as well as internal factors

EXTERNAL FACTORS:-

Ineffective recovery tribunal

The Govt. has set of numbers of recovery tribunals, which works for recovery of loans and

advances. Due to their negligence and ineffectiveness in their work the bank suffers the

consequence of non-recover, thereby reducing their profitability and liquidity.

Willful Defaults

There are borrowers who are able to pay back loans but are intentionally withdrawing it. These

groups of people should be identified and proper measures should be taken in order to get back

the money extended to them as advances and loans.

Natural calamities

This is the measure factor, which is creating alarming rise in NPAs of the PSBs. every now and

then India is hit by major natural calamities thus making the borrowers unable to pay back

there loans. Thus the bank has to make large amount of provisions in order to compensate

those loans, hence end up the fiscal with a reduced profit. Mainly ours farmers depends on rain

fall for cropping. Due to irregularities of rain fall the farmers are not to achieve the production

level thus they are not repaying the loans.

Industrial sickness

48

Improper project handling , ineffective management , lack of adequate resources , lack of

advance technology , day to day changing govt. Policies give birth to industrial sickness. Hence

the banks that finance those industries ultimately end up with a low recovery of their loans

reducing their profit and liquidity.

Lack of demand

Entrepreneurs in India could not foresee their product demand and starts production which

ultimately piles up their product thus making them unable to pay back the money they borrow to

operate these activities. The banks recover the amount by selling of their assets, which covers a

minimum label. Thus the banks record the non-recovered part as NPAs and have to make

provision for it.

Change on Govt. policies

With every new govt. banking sector gets new policies for its operation. Thus it has to cope with

the changing principles and policies for the regulation of the rising of NPAs.The fallout of

handloom sector is continuing as most of the weavers Co-operative societies have become

defunct largely due to withdrawal of state patronage. The rehabilitation plan worked out by the

Central government to revive the handloom sector has not yet been implemented. So the over

dues due to the handloom sectors are becoming NPAs.

INTERNAL FACTORS:-

Defective Lending process

There are three cardinal principles of bank lending that have been followed by the commercial

banks since long.

i. Principles of safety

ii. Principle of liquidity

iii. Principles of profitability

I. Principles of safety :-

49

By safety it means that the borrower is in a position to repay the loan both principal and interest.

The repayment of loan depends upon the borrowers:

a) Capacity to pay

b) Willingness to pay

a) Capacity to pay depends upon:

1. Tangible assets

2. Success in business

b) Willingness to pay depends on:

1. Character

2. Honest

3. Reputation of borrowe

The banker should, therefore take utmost care in ensuring that the enterprise or business for

which a loan is sought is a sound one and the borrower is capable of carrying it out successfully

.He should be a person of integrity and good character.

Inappropriate technology

Due to inappropriate technology and management information system, market driven decisions

on real time basis cannot be taken. Proper MIS and financial accounting system is not

implemented in the banks, which leads to poor credit collection, thus NPA. All the branches of

the bank should be computerized.

Improper SWOT analysis

The improper strength, weakness, opportunity and threat analysis is another reason for rise in

NPAs. While providing unsecured advances the banks depend more on the honesty, integrity,

and financial soundness and credit worthiness of the borrower.

Banks should consider the borrowers own capital investment.

50

It should collect credit information of the borrowers from-

a. From bankers.

b. Enquiry from market/segment of trade, industry, business.

c. From external credit rating agencies.

Analyze the balance sheet.

True picture of business will be revealed on analysis of profit/loss a/c and balance sheet.

Purpose of the loan

When bankers give loan, he should analyse the purpose of the loan. To ensure safety and

liquidity, banks should grant loan for productive purpose only. Bank should analyse the

profitability, viability, long term acceptability of the project while financing.

Poor credit appraisal system

Poor credit appraisal is another factor for the rise in NPAs. Due to poor credit appraisal the bank

gives advances to those who are not able to repay it back. They should use good credit

appraisal to decrease the NPAs.

Managerial deficiencies

The banker should always select the borrower very carefully and should take tangible assets as

security to safe guard its interests. When accepting securities banks

Should consider the--

1. Marketability

2. Acceptability

3. Safety

4. Transferability.

The banker should follow the principle of diversification of risk based on the famous

maxim “do not keep all the eggs in one basket”; it means that the banker should not grant

advances to a few big farms only or to concentrate them in few industries or in a few cities. If a

51

new big customer meets misfortune or certain traders or industries affected adversely, the

overall position of the bank will not be affected. Like OSCB suffered loss due to the OTM

Cuttack, and Orissa hand loom industries. The biggest defaulters of OSCB are the OTM

(117.77lakhs), and the handloom sector Orissa hand loom WCS ltd (2439.60lakhs).

Absence of regular industrial visit

The irregularities in spot visit also increases the NPAs. Absence of regularly visit of bank

officials to the customer point decreases the collection of interest and principals on the loan.

The NPAs due to willful defaulters can be collected by regular visits.

Re loaning process

Non remittance of recoveries to higher financing agencies and re loaning of the same have

already affected the smooth operation of the credit cycle. Due to re loaning to the defaulters and

CCBs and PACs, the NPAs of OSCB is increasing day by day.

PROBLEMS DUE TO NPA

1. Owners do not receive a market return on their capital .in the worst case, if the banks fails,

owners lose their assets.

In modern times this may affect a broad pool of shareholders.

2. Depositors do not receive a market return on saving. In the worst case if the bank fails,

depositors lose their assets or uninsured balance.

3. Banks redistribute losses to other borrowers by charging higher interest rates, lower deposit

rates and higher lending rates repress saving and financial market, which hamper economic

growth

4. . Nonperforming loans epitomize bad investment. They misallocate credit from good projects,

which do not receive funding, to failed projects. Bad investment ends up in misallocation of

capital, and by extension, labour and natural resources.

52

Nonperforming asset may spill over the banking system and contract the money stock, which

may lead to economic contraction. This spill over effect can channelize through liquidity or bank

insolvency:

a) When many borrowers fail to pay interest, banks may experience liquidity shortage. This can

jam payment across the country.

b) Illiquidity constraints bank in paying depositors

c) Undercapitalized banks exceed the bank’s capital base

TYPES OF NPA

A] Gross NPA

B] Net NPA

A] Gross NPA:

Gross NPAs are the sum total of all loan assets that are classified as NPAs as per RBI

guidelines as on Balance Sheet date. Gross NPA reflects the quality of the loans made by

banks. It consists of all the non-standard assets like as sub-standard, doubtful, and loss assets.

It can be calculated with the help of following ratio:

Gross NPAs Ratio = Gross NPAs / Gross Advances

B] Net NPA:

Net NPAs are those type of NPAs in which the bank has deducted the provision regarding

NPAs. Net NPA shows the actual burden of banks. Since in India, bank balance sheets contain

a huge amount of NPAs and the process of recovery and write off of loans is very time

consuming, the provisions the banks have to make against the NPAs according to the central

bank guidelines, are quite significant. That is why the difference between gross and net NPA is

quite high.

It can be calculated by following

Net NPAs = Gross NPAs – Provisions

Gross Advances – Provision

53

Classification of NPA / Asset classification

Once an asset falls under the NPA category, banks are required by the Reserve Bank of India

(RBI) to make provision for the uncollected interest on these assets. For the purpose they have

to classify their assets based on the strength and on collateral securities into:

1. Substandard Assets - Which has remained NPA for a period less than or equal to 12

months.

This is not a non-performing asset. It does not carry more than normal risk attached to the

business.

2. Doubtful Assets- Which has remained in the sub-standard category for a period of 12

Months.

3. Loss Assets –

Where loss has been identified by the bank or internal or external auditors or the RBI

inspection but the amount has not been written off wholly.

It is an asset identified by the bank, auditors or by the RBI inspection as a loss asset. It is

an asset for which no security is available or there is considerable erosion in the realizable

value of the security

INDIAN ECONOMY AND NPAS

Undoubtedly the world economy has slowed down, recession is at its peak, globally stock

markets have tumbled and business itself is getting hard to do. The Indian economy has been

much affected due to high fiscal deficit, poor infrastructure facilities, sticky legal system, cutting

of exposures to emerging markets by FIIs, etc.

Further, international rating agencies like, Standard & Poor have lowered India's credit rating to

sub-investment grade. Such negative aspects have often outweighed positives such as

increasing forex reserves and a manageable inflation rate.

Under such a situation, it goes without saying that banks are no exception and are bound to

face the heat of a global downturn. One would be surprised to know that the banks and financial

54

institutions in India hold non-performing assets worth Rs. 1,10,000 crores. Bankers have

realized that unless the level of NPAs is reduced drastically, they will find it difficult to survive.

The actual level of Non Performing Assets in India is around $40 billion much higher than

government’s estimation of $16 billion. This difference is largely due to the discrepancy in

accounting the NPAs followed by India and rest of the world. The Accounting norms of the India

are less stringent than those of the developed economies. The Indian banks also have the

tendency to extend the past dues. Considering the GDP of India nearly $470 billion, the NPAs

are 8% of total GDP, which was better than the many Asian countries. the NPA of china was

45%of the GDP, while Japan had NPAs of 25% of the GDP and Malaysia had 42%.

The aggregate level of the NPAs in Asia has increased from $1.5 billion in 2000 to $2 billion in

2002.looking to such overall picture of the market, we can say that India is performing well and

the steps taken are looking favourable.

UNDERLYING REASONS FOR NPAS IN INDIA

An internal study conducted by RBI shows that in the order of prominence, the following factors

contribute to NPAs.

Internal Factors

Diversion of funds for

Expansion/diversification/modernization

Taking up new projects

Helping/promoting associate concerns time/cost overrun during the project

implementation stage

Business (product, marketing, etc.) failure

Inefficiency in management

Slackness in credit management and monitoring

Inappropriate technology/technical problems

Lack of co-ordination among lenders

55

External Factors

Recession

Input/power shortage

Price escalation

Exchange rate fluctuation

Accidents and natural calamities, etc.

Changes in Government policies in excise/ import duties, pollution control orders, etc.

As mentioned earlier, we held discussions with lenders and financial sector experts on the

causes of NPAs in India and whilst the above-mentioned causes we reaffirmed, some others

were also mentioned. A brief discussion is provided below.

Liberalization of economy/removal of restrictions/reduction of tariffs

A large number of NPA borrowers were unable to compete in a competitive market in which

lower prices and greater choices were available to consumers. Further, borrowers operating in

specific industries have suffered due to political, fiscal and social compulsions, compounding

pressures from liberalization (e.g., sugar and fertilizer industries)

Lax monitoring of credits and failure to recognize Early Warning Signals

It has been stated that approval of loan proposals is generally thorough and each proposal

passes through many levels before approval is granted. However, the monitoring of sometimes-

complex credit files has not received the attention it needed, which meant that early warning

signals were not recognized and standard assets slipped to NPA category without banks being

able to take proactive measures to prevent this. Partly due to this reason, adverse trends in

borrowers' performance were not noted and the position further deteriorated before action was

taken.

Over optimistic promoters

Promoters were often optimistic in setting up large projects and in some cases were not fully

above board in their intentions. Screening procedures did not always highlight these issues.

Often projects were set up with the expectation that part of the funding would be arranged from

56

the capital markets, which were booming at the time of the project appraisal. When the capital

markets subsequently crashed, the requisite funds could never be raised, promoters often lost

interest and lenders were left stranded with incomplete/unviable projects.

Directed lending

Loans to some segments were dictated by Government's policies rather than commercial

imperatives.

Highly leveraged borrowers

Some borrowers were undercapitalized and over burdened with debt to absorb the changing

economic situation in the country. Operating within a protected market resulted in low

appreciation of commercial/market risk.

Funding mismatch

There are said to be many cases where loans granted for short terms were used to fund long

term transactions.

High Cost of Funds

Interest rates as high as 20% were not uncommon. Coupled with high leveraging and falling

demand, borrowers could not continue to service high cost debt.

Willful Defaulters

There are a number of borrowers who have strategically defaulted on their debt service

obligations realizing that the legal recourse available to creditors is slow in achieving results.

CHECK LIST FOR REDUCTION OF NPA’s:

Early identification:

I) Identification of accounts showing early warning signals

II) High values NPA’s should be given focused attention

III) A systematic review of problems loans should be done. The time norms for the problem loan

review should be adhered to. Action plan to be drawn up for each account and follow up.

Recovery:

57

Actual recovery occurs in the accounting in which the total recovery of the dues is warranted.

Through regular pre and post sanction monitoring, follow-ups, the NPA’s can be eliminated.

Up gradation:

The NPA accounts in which part recovery of the total, dues will upgrade the account from NPA

to performing asset. Generally the NPA accounts with less than 2 years of the age under NPA

are covered. The main characteristic of these accounts is after elimination from NPA, also these

accounts continued to be part of advances. Since lending is a main business of the banks up

gradation of accounts is preferred.

Substandard accounts to be specially targeted for up gradation

Up gradation strategies would include adjustment of irregularity, repayment of overdue

interest/installment and up gradation following restructuring/ rehabilitation

Replacement/re-schedulement of loans should be done in deserving cases promptly. After 1

year of successful implementation, account to be reviewed for up gradation

Rehabilitation:

Rehabilitation of units should be taken up in deserving cases

Repayment:

Fixing repayment programme for accounts while continued viability is in doubt.

Fixing installments for irregular amount were limits to be continued with reduced exposure.

Compromise:

Through compromise the accounts are closed by negotiated settlement with the borrowers as

per the compromise policy of the bank. Generally compromises are encouraged in cases of

chronic NPA accounts.

Compromise proposals need to be considered where necessary, and in time.

Option of OTS through Lok Adalat should be examined.

58

RECOVERY TOOLS AND THEIR EFFECTIVENESS:

1. DEBT RECOVERY TRIBUNALS:

Lack of expeditious court remedies has been one of the major impediments experienced by

banks and financial institutions in the recovery of NPA. On the basis of the recommendation of

Tiwari Committee(1981) and Narsimham Committee on financial systems(1991), which

emphasized the need for the establishment of special tribunals for banks and financial

institutions, the recovery of debts due to banks and financial institutions act was enacted

in1993.

The act applies only to cases where the amount of debt due to banks/financial institution is Rs

10 lakhs or above. Filing of cases at the DRT has been a cause of concern for almost every

bank in the country today. One reason for the slow pace is the requisite infrastructure at the

respective DRT was inadequate to handle the huge number of cases pending with it. There has

been a decision to add about 7 more DRT to the existing 22 DRT and 5 appellate authorities.

This enables the banks to settle some of the pending NPAs.

2. LOK ADALATS:

For recovery of smaller loans, the Lok Adalat has proved a very good agency for quick justice

and settlement of dues. The Gujarat State Legal Service Authority and the DRT, Ahmadabad

have nominated and appointed conciliators to deal with the cases before the Lok Adalat

comprising of retired High Court Judge and two members from senior

advocates/industrialists/executives of the banks. These Adalats in the state of Gujarat have

been found to be useful as supplement to the efforts of the efforts of the recovery by the DRTs.

Such agencies should be established in all the states.

3. ASSET RECONSTRUCTION COMPANY:

The setting of Asset Reconstruction Company may be another channel to discount the NPAs of

the bank to such an agency and to developing the process of securitization of banks loan assets

for providing liquidity. Perhaps secondary market of derivatives based on securitized assets

could also be developed as in individual countries.

4. REVENUE RECOVERY ACT: In some states, revenue recovery act has been made

applicable to banks. Since this is also expeditious process of adjudicating claims, banks

may be notified to cover the Act by state.

59

60

REVIEW LITERETURE

1. According to Paul M. Healy and James Michael Wahlen The academic evidence on earnings

management and its implications for accounting standard setters and regulators. We structure

our review around questions likely to be of interest to standard setters. Specifically, we review

the empirical evidence on which particular accruals are used to manage earnings, the

61

magnitude and frequency of any earnings management, and whether earnings management

affects resource allocation in the economy. Our review identifies a number of important

opportunities for future research on earnings management.

2. According to David Bernstein Asset quality is shown to affect both the level of bank costs and

estimates of scale economies in banking. Cost functions estimated with banks which have

low/high non-performing loan ratios differ from cost curves estimated over the entire sample.

The empirical results confirm that an increase in non-performing loans increases costs. The cost

curve estimated for banks with low non-performing ratios suggests that scale economies may

exist even for the largest banks.

3. According to Guonan Ma Ben S.C. Fung (Bank of Canada) to address the banking system's

non-performing loan (NPL) problem, the Chinese government set up four asset management

corporations (AMCs). They were to buy up bad debts of the big four state-owned commercial

banks and dispose of them over 10 years, taking a large step towards NPL resolution. But in

their first two years, these AMCs have made only a limited contribution to resolution of the NPL

problem.

4. According to LI Peng-yan,LIU Gang (School of Humanities and Social Sciences,Harbin

Institute of Technology,Harbin 150001,China) Aiming at the securitization risk of non-

performing assets in commercial banks in China, an analytic hierarchy process was employed

to evaluate the problem.The analysis result showed that when securitizing non-performing

assets, credit risk became the most important risk that commercial banks faced.Moreover,this

paper pointed out that improving the credit environment and perfecting the credit system were

the focus and direction to avoid the securitization risk of non-performing assets of commercial

banks in China.

5. According to Daniela Klingebiel Asset management companies have been used to address the overhang

of bad debt in a country's financial system - by expediting corporate restructuring or rapidly disposing of

corporate assets. A study of seven cases suggests that such companies tend to be ineffective at

corporate restructuring and are good at disposing of assets only when they're used to meet fairly

narrow objectives in the presence of certain factors.

6. According to Larry G. Meeker and Laura Gray Federal Reserve Bank of Kansas City,

Kansas City, In 1983, the public was given its first opportunity to review bank asset

62

quality in the form of non-performing asset information. The purpose of this study is to

evaluate that information. A regression analysis comparing the non-performing asset

statistics with examiner classifications of assets suggests that the non-performing asset

information can be useful aid in analyzing the asset quality of banks, particularly when

the information is timely.

7. According to Nicholas R. Lardy So far China has avoided Southeast Asia's financial crisis, but

it shares many of the underlying weaknesses that brought on the panic. Although it lacks capital

convertibility and the high foreign borrowing that imperiled other countries, its weak banking

system has issued a mountain of bad loans. Shenzhen has enough empty office space, for

instance, to satisfy the market for three years. New reforms are supposed to reduce political

nepotism in lending and apply the ax to subpar bank presidents, but whether they will succeed

remains to be seen.

8. According to Joe Peek and Eric S. Rosengren The size of Japanese bank lending operations

in the United States enables us to use U.S. banking data to investigate the extent to which the

sharp decline in Japanese stock prices was transmitted to the United States via U.S. branches

of Japanese parent banks, as well as to identify a supply shock to U.S. bank lending that is

independent of U.S. loan demand. We find that binding risk-based capital requirements

associated with the Japanese stock market decline resulted in a decrease in lending by

Japanese banks in the United States that was both economically and statistically significant.

9. According to Quigley John M. Activities in the real estate markets in Southeast and East Asian

economies were an important contributing force to the financial crises of 1997 in the Asian

economies. The analysis relies upon unpublished data reported contemporaneously by financial

institutions and market watchers to document the extent of the imbalances in the real property

market that were evident to informed observers at the time of the financial collapse. The

analysis argues that a series of reforms in the regulation of the property market and the

treatment of real property loans by financial institutions are necessary to prevent the recurrence

of the kind of speculative bubble that contributed to the financial crises in Asia.

10. According to Mr.SIBICHAN.C.J. NPAs have turned to be a major stumbling block affecting the

profitability of Indian banks before 1992,banks did not disclose the bad debts sustained by them

and provision made by them fearing that it may have an adverse. Owing to the low levels of

profitability, banks owned funds had to be strengthened by repeated infusion of additional

capital by the government. The introduction of prudential norms strengthen the banks financial

63

position and enhance transparency is considered as a milestone measure in the financial sector

reform. These prudential norms relate to income recognition, asset classification, provisioning

for bad and doubtful debts and capital adequacy.

11. According to Tariq Ahmad Wani, The problem of non-performing assets has been a major

issue for the banking industry. The RBI which is the apex body for controlling the level of non-

performing assets has been giving guidelines and getting norms for the banks in order to

control the incidents of defaults. This study on management of non-performing assets with

specific reference to J&K bank was conducted, to find out the reasons for the incidence of non-

performing assets and how public sector banks managed it and its effect on performance of the

bank

The NPA of Jammu & Kashmir Bank Limited was studied and it was observed that all

branches of bank had NPA.

The study revealed that the J&K bank has been successful in controlling its level of Non-

performing assets as compared to the recent banking industry trends.

The causes for NPA in Jammu & Kashmir Bank Limited were analyzed, the extent to

which profitability has been reduced, was also analyzed.

12. According to Asli Demirguc – Kunt Vulnerability to crises in the banking sector appears to be

associated with these factors: a weak macroeconomic environment characterized by slow GDP

growth and high inflation, vulnerability to sudden capital outflows, low liquidity in the banking

sector, a high share of credit to the private sector, past credit growth, the existence of explicit

deposit insurance, and weak institutions.

13. According to Viral V.Acharya effect of focus (specialization) vs. diversification on the return and

the risk of banks using data from 105 Italian banks over the period 1993 1999. Specifically, we

analyze the tradeoffs between (loan portfolio) focus and diversification using a unique data set

that is able to identify individual bank loan exposures to different industries, to different sectors,

and to different geographical regions

14. According to Aman Dhall & Raja Awasthi,

NEW DELHI: If non-performing assets (NPAs) are any parameter to judge the efficiency of

banks, then private sector such as ICICI Bank and HDFC Bank surely need to take a lesson or

two from the public sector banks on how to clean bad debts from their books.

64

In the financial year 2007-’08, even as public sector banks (barring State Bank of Saurashtra)

put up an inspired show to drastically reduce the NPAs, the two private majors — ICICI Bank

and HDFC Bank — have struggled to fix the problem of higher proportion of non-performing

debt (see table). While in the case of HDFC Bank the increase in the gross NPAs in percentage

terms is marginal (1.5 %), there are worrying signs for India’s largest private bank, ICICI Bank

which witnessed a rise of approximately 59% in the gross NPAs in percentage terms.

15. According to Sathish Kumar

In liberalizing economy banking and financial sector get high priority. Indian banking sector of

having a serious problem due non performing. The financial reforms have helped largely to

clean NPA was around Rs. 52,000 crores in the year 2004. The earning capacity and

profitability of the bank are highly affected due to this

NPA is defined as an advance for which interest or repayment of principal or both remain out

standing for a period of more than two quarters. The level of NPA act as an indicator showing

the bankers credit risks and efficiency of allocation of resource.

16. According to Richard Podpiera Substantial effort has been devoted to reforming China's

banking system in recent years. The authorities recapitalized three large state-owned banks,

introduced new governance structures, and brought in foreign strategic investors. However, it

remains unclear the extent to which currently reported data reflect the true credit risk in loan

portfolios and whether lending decisions have started to be taken on a commercial basis. We

examine lending growth, credit pricing, and regional patterns in lending from 1997 through 2004

to look for evidence of changing behavior of the large state-owned commercial banks (SCBs).

We find that the SCBs have slowed down credit expansion, but that the pricing of credit risk

remains undifferentiated and banks do not appear to take enterprise profitability into account

when making lending decisions. Controlling for several factors, we find that large SCBs have

continued to lose market share to other financial institutions in provinces with more profitable

enterprises. The full impact of the most recent reforms will become clear only in several years,

however, and these issues should be revisited in future research.

17. According to Brenda Gonzalez-Hermosillo, Ceyla Pazarbaşioğlu and Robert Billings The

proposition that bank fragility is determined by bank-specific factors, macroeconomic conditions,

and potential contagion effects. The methodology allows the variables that determine bank

failure to differ from those that influence banks' time to failure (or survival rate). Based on the

65

indicators of fragility of individual banks, we construct an index of fragility for the banking

system. The framework is applied to the Mexican financial crisis that began in 1994. For Mexico,

bank-specific variables and contagion effects explain the likelihood, whereas macroeconomic

variables largely determine the timing, of bank failure.

18. According to Milind Sathye Productive efficiency of banks in a developing country, that is,

India. The measurement of efficiency is done using data envelopment analysis. Two

models have been constructed to show how efficiency scores vary with change in inputs

and outputs. The efficiency scores, for three groups of banks, that is, publicly owned,

privately owned and foreign owned, are measured.

19. According to Katherine A. Samolyk the empirical relationship between banking

conditions and economic performance at the state level. We develop a regional credit

view to explain how, due to information costs, regional banking conditions can affect

local economic activity by impacting on a region's ability to fund local investments.

Localized information costs suggest that banking-sector problems may constrain

economic activity in financially distressed regions, whereas no such link need be

evident in financially sound regions.

20. According to Vibha Jain the challenges facing the banking industry in India in tackling the

bargaining problem of Non-Performing Assets (NPAs). It traces the history of growth of NPAs in

the banking industry caused initially by directed lending due to strong government hold on

banks. The government control also kept the issue under wraps for a long time, understanding

the enormity of the problem only at the advent of economic reforms in early nineties. The book

elucidates the various measures taken by Reserve Bank of India to Control NPAs over the last

decade and a half and critically analyses the success obtained in containing the same. It also

provides an international perspective by highlighting the problem of NPAs in other South East

Asian countries and the measures taken by them to solve the issue.

66

RESEARCH METHODOLOGY

1. Significance of the study

67

The main aim of any person is the utilization money in the best manner since the India is country

were more than half of the population has problem of running the family in the most efficient

manner. However Indian people faced large number of problem till the development of the full-

fledged banking sector. The Indian banking sector came into the developing nature mostly after

the 1991 government policy. The banking sector has really helped the Indian people to utilise the

single money in the best manner as they want. People now have started investing their money in

the banks and banks also provide good returns on the deposited amount. The people now have

at the most understood that banks provide them good security to their deposits and so excess

amounts are invested in the banks. Thus, banks have helped the people to achieve their socio

economic objectives.

The main aim behind making this report is to know how Public Sector Banks are operating their

business and how NPAs play its role to the operations of the Public Sector Banks. The report

NPAs are classified according to the sector, industry, and state wise. The present study also

focuses on the existing system in India to solve the problem of NPAs and comparative analysis

to understand which bank is playing what role with concerned to NPAs.Thus, the study would

help the decision makers to understand the financial performance and growth of Public Sector

Banks as compared to the NPAs.

2. Objective of the study

Primary objective:

The primary objective of the making report is:

To know why NPAs are the great challenge to the Public Sector Banks

Secondary objectives:

The secondary objectives of preparing this report are:

To understand what is Non Performing Assets and what are the underlying reasons for

the emergence of the NPAs.

To understand the impacts of NPAs on the operations of the Public Sector Banks.

To know what steps are being taken by the Indian banking sector to reduce the NPAs?

68

To evaluate the comparative ratios of the Public Sector Banks with concerned to the

NPAs.

3. Research methodology

The research methodology means the way in which we would complete our prospected task.

Before undertaking any task it becomes very essential for any one to determine the problem of

study. I have adopted the following procedure in completing my report study.

1. Formulating the problem

2. Research design

3. Determining the data sources

4. Analysing the data

5. Interpretation

6. Preparing research report

(1) Formulating the problem

Providing credit facility to the borrower is one of the important factors as far as the banking

sector is concerned. On the basis of the analyzed factor, I felt that the important issue right now

as far as the credit facilities are provided by bank is non performing assets. I started knowing

about the basics of the NPAs and decided to study on the NPAs. So,

(2) Research Design

The research design tells about the mode with which the entire project is prepared. My research

design for this study is basically analytical. Because I have utilised the large number of data of

the Public Sector Banks.

(3) Determining the data source

The data source can be primary or secondary. The primary data are those data which are used

for the first time in the study. However such data take place much time and are also expensive.

Whereas the secondary data are those data which are already available in the market. These

data are easy to search and are not expensive too. for my study I have utilised totally the

secondary data.

69

(4) Analysing the data

The primary data would not be useful until and unless they are well edited and tabulated. When

the person receives the primary data many unuseful data would also be there. So, I analysed

the data and edited them and turned them in the useful tabulations. So, that can become useful

in my report study.

(5) Interpretation of the data

With use of analysed data I managed to prepare my project report. But the analyzing of data

would not help the study to reach towards its objectives. The interpretation of the data is

required so that the others can understand the crux of the study in more simple way without any

problem so I have added the chapter of analysis that would explain others to understand my

study in simpler way.

(6) Project writing

This is the last step in preparing the project report. The objective of the report writing was to

report the findings of the study to the concerned authorities.

4. Limitations of the study

The limitations that I felt in my study are:

It was critical for me to gather the financial data of the every bank of the Public Sector

Banks so the better evaluations of the performance of the banks are not possible.

Since my study is based on the secondary data, the practical operations as related to

the NPAs are adopted by the banks are not learned.

Since the Indian banking sector is so wide so it was not possible for me to cover all the

banks of the Indian banking sector.

70

DATA ANALYSIS AND INTERPRETATION

71

Following are the Public sector Banks included

for the Ratio analysis .

1. Allahabad Bank

2. Andhra Bank

3. Bank of Baroda

4. Bank of India

5. Bank of Maharashtra

6. Canara Bank

7. Central Bank of India

8. Corporation Bank

9. Dena Bank

10. Indian Bank

11. Indian Overseas bank

12. Oriental Bank of Commerce

13. Punjab National Bank

14. Punjab and Sind Bank

15. State Bank of India

16. State Bank of India & its associates.

State Bank of Hyderabad

State Bank of India

State Bank of Indore

72

State Bank of Mysore

State Bank of Bikaner & jaipur

State Bank of Saurashtra

State Bank of Travancore

17. Syndicate Bank

18. UCO Bank

19. Union Bank of India (UBI)

20. Vijaya Bank

73

RATIO ANALYSIS

4.1 GROSS NPA RATIO:

Gross NPA Ratio is the ratio of gross NPA to gross advances of the Bank. Gross NPA is the

sum of all loan assets that are classified as NPA as per the RBI guidelines. The ratio is to be

counted in terms of percentage and the formula for GNPA is as follows:

Gross NPA ratio = (Gross NPA / Gross advances)*100

Gross NPAs to Gross Advances

S. no Name of the bank

2009 2010 2011 2012

1 2 3 4 5 6

Nationalized bank

1 Allahabad bank 3.9 2.6 2.0 1.8

2 Andhra bank 1.9 1.4 1.1 0.8

3 Bank of Baroda 3.9 2.5 1.8 1.3

4 Bank of India 3.7 2.4 1.7 1.7

5 Bank of Maharashtra 5.5 3.5 2.6 2.3

6 Canara Bank 2.3 1.5 1.3 1.6

7 Central Bank of India 6.8 4.8 3.2 2.7

8 Corporation Bank 2.6 2.1 1.5 1.1

9 Dena Bank 6.4 4.1 2.4 2.1

10 Indian Bank 2.9 1.9 1.2 0.9

11 Indian Overseas Bank 3.4 2.3 1.6 2.5

12 Oriental Bank of Commerce

6.0 3.2 2.3 1.5

13 Punjab & Sind Bank 9.6 2.4 0.7 0.7

14 Punjab National Bank 4.1 3.5 2.7 1.8

15 Sydnicate Bank 4.0 3.0 2.7 1.9

74

16 UCO Bank 3.3 3.2 3.0 2.2

17 Union Bank of India 3.8 2.9 2.2 2.0

18 United Bank of India 4.7 3.6 2.7 2.9

19 Vijaya Bank 3.2 2.3 1.6 1.9

20 State Bank of India 3.9 2.9 3.0 2.8

21 State Bank of Bikaner & Jaipur

2.4 2.2 1.7 1.6

22 State Bank of Hyderabad 2.1 1.2 0.9 1.1

23 State Bank of Indore 3.0 1.9 1.4 1.4

24 State Bank of Mysore 3.3 2.3 1.7 1.4

25 State Bank of Patiala 2.4 1.8 1.4 1.3

26 State Bank of Saurashtra 2.0 1.2 1.5 --

27 State Bank of Travanore 3.2 2.2 2.0 1.7

Findings from the above table :

The table above indicates the quality of credit portfolio of the banks. High gross NPA

ratio indicates the low credit portfolio of bank and vice-a-versa.

We can see from the above table that the United Bank of India has the higher gross NPA

ratio of 2.9 % followed by the State Bank of India with 2.8%. The Central Bank of India

also have higher gross NPA ratio with 2.7% in 2012.

Whereas the state Andhra Bank , Punjab & Sind Bank , Indian Bank showed lower ratio

with 0.8%, 0.7 % and 0.9% in the year 2012.

4.2 NET NPA RATIO:

The net NPA percentage is the ratio of net NPA to net advances, in which the provision

is to be deducted from the gross advance. The provision is to be made for NPA account.

The formula for that is:

75

Net NPA Ratio = (Gross NPA-Provision /Gross Advances-Provisions) * 100

S.no Name of Bank 2009 2010 2011 2012

1 2 3 4 5 6

Nationalized Bank

1 Allahabad Bank 0.84 1.07 0.80 0.7

2 Andhra Bank 0.24 0.17 0.53 0.2

3 Bank of Baroda 0.87 0.60 0.47 0.3

4 Bank of India 1.49 0.74 0.52 0.4

5 Bank of Maharashtra 2.03 1.21 0.87 0.8

6 Canara Bank 1.12 0.94 0.84 1.1

7 Central Bank of India 2.59 1.70 1.45 1.2

8 Corporation Bank 0.64 0.47 0.32 0.3

9 Dena Bank 3.04 1.99 0.94 1.1

10 Indian Bank 0.79 0.35 0.24 0.2

11 Indian Overseas Bank 0.65 0.55 0.60 1.3

12 Oriental Bank 0.49 0.49 0.49 0.7

13 Punjab & Sind Bank 2.43 0.66 0.37 0.3

14 Punjab National Bank 0.29 0.76 0.64 0.2

15 Sydnicate Bank 0.86 0.76 0.97 0.8

16 UCO Bank 2.10 2.14 1.98 1.2

17 Union Bank of India 1.56 0.96 0.17 0.3

18 United Bank of India 1.95 1.50 1.10 1.5

76

19 Vijya Bank 0.85 0.59 0.57 0.8

20 State Bank of India 1.88 1.56 1.78 1.8

21 State Bank of Bikaner & Jaipur

1.18 1.09 0.83 0.9

22 State Bank of Hyderabad 0.36 0.22 0.16 0.4

23 State Bank Of Indore 1.83 1.04 0.73 0.5

24 State Bank Of Mysore 0.74 0.45 0.43 0.6

25 State Bank of Patiala 0.99 0.83 0.60 ---

26 State Bank of Saurashtra 1.16 0.70 0.91 0.6

27 State Bank of Travancore 1.47 1.08 0.94 0.9

Findings from the above table :

High NPA ratio indicates the high quantity of risky assets in the Banks for which no

provision are made.

From the table it becomes clear that the NPA ratio of almost all the Banks have been

improved quite well as compared to the previous year.

The State Bank of India has the highest NPA ratio of 1.8 % followed by the United Bank

of India with 1.5 % & Indian Overseas Bank with 1.3%, Central Bank Of India and UCO

Bank with 1.2% The Andhra Bank has showed the lowest NPA ratio 0.2% and Punjab

National Bank also showed the lowest NPA ratio 0.2%, Bank of Baroda and Bank of

India have also showed lower NPA ratio with 0.3% and 0.4 % in 2012.

4.3 PROVISION RATIO:

Provisions are to be made to keep safety against the NPA, & it directly affect on the gross

profit of the Banks.

The provision Ratio is nothing but total provision held for NPA to gross NPA of the Banks.

77

The formula for that is,

(i) Provision Ratio = (Total Provision/Gross NPA)*100

(ii) [ Additional Formulae: Net NPA = Gross NPA – Provision

Therefore, Provision = Gross NPA – Net NPA]

S.no Name of Bank 2009 2010 2011 2012

1 2 3 4 5 6

Nationalized Bank

1 Allahabad Bank 79.21 59.78 60.43 61.11

2 Andhra Bank 87.99 88.09 85.58 75.00

3 Bank of Baroda 78.32 76.02 75.09 76.92

4 Bank of India 60.89 69.91 69.34 76.47

5 Bank of Maharashtra 64.61 66.18 36.48 65.21

6 Canara Bank 50.95 37.93 36.48 31.25

7 Central Bank of India 63.78 65.86 54.89 55.55

8 Corporation Bank 75.41 77.27 78.28 72.72

9 Dena Bank 54.45 0.99 62.37 47.61

10 Indian Bank 73.59 81.28 79.95 77.77

11 Indian Overseas Bank 8.4 76.98 63.56 48.00

12 Oriental Bank 92.29 85.16 57.90 53.33

13 Punjab & Sind Bank 76.58 73.51 50.58 57.14

78

14 Punjab National Bank 93.3 78.59 77.29 88.88

15 Sydnicate Bank 79.25 74.93 64.79 87.89

16 UCO Bank 36.42 33.2 33.87 45.45

17 Union Bank of India 60.25 67.89 92.29 85.00

18 United Bank of India 59.27 59.24 59.78 48.27

19 Vijya Bank 73.65 74.48 64.49 57.89

20 State Bank of India 48.98 47.41 42.16 35.71

21 State Bank of Bikaner & Jaipur

51.85 51.88 42.16 43.75

22 State Bank of Hyderabad 83.35 82.52 81.73 63.63

23 State Bank Of Indore 39.02 45.93 49.69 64.28

24 State Bank Of Mysore 78.28 80.48 75.10 57.14

25 State Bank of Patiala 37.58 54.53 58.34 ----

26 State Bank of Saurashtra 37.58 36.65 36.71 -----

27 State Bank of Travancore 54.68 50.45 53.10 47.05

Findings from the above table

This Ratio indicates the degree of safety measures adopted by the Banks.

It has direct bearing on the profitability, Dividend and safety of shareholders’ fund.

If the provision ratio is less, it indicates that the Banks has made under provision.

79

The highest provision ratio is showed by Punjab National Bank India with 88.88%

followed by

Sydnicate Bank with 87.89 % & Union Bank of India in the year 2012.

The lowest provision ratio is showed Canara Bank with only 31.27 % followed by State

Bank of India with 35.71% State Bank of Bikaner & Jaipur With 43.75%

4.4 PROBLEM ASSET RATIO:

It is the ratio of gross NPA to total asset of the bank. The formula for that is

Problem Asset Ratio = (Gross NPAs/Total Assets) * 100

S.no Name of Bank 2009 2010 2011 2012

1 2 3 4 5 6

Nationalized Bank

1 Allahabad Bank 2.14 1.61 1.21 1.1

2 Andhra Bank 1.07 0.83 0.66 0.5

3 Bank of Baroda 2.10 0.14 1.10 0.8

4 Bank of India 2.20 1.48 1.07 1.1

5 Bank of Maharashtra 3.02 2.10 1.59 1.4

6 Canara Bank 1.35 0.90 0.78 1.0

7 Central Bank of India 3.59 2.76 1.90 1.6

8 Corporation Bank 1.54 1.18 0.88 0.6

9 Dena Bank 3.57 2.36 1.48 1.3

10 Indian Bank 1.40 0.97 0.70 0.5

11 Indian Overseas Bank 1.69 1.36 0.98 1.6

80

12 Oriental Bank of Commerce 3.31 1.96 1.41 0.9

13 Punjab & Sind Bank 3.31 1.32 0.44 0.4

14 Punjab National Bank 4.94 2.08 1.67 1.1

15 Sydnicate Bank 2.16 3.79 0.16 1.2

16 UCO Bank 0.24 2.01 1.84 1.4

17 Union Bank of India 1.00 1.82 1.34 1.2

18 United Bank of India 2.35 1.93 1.40 1.6

19 Vijya Bank 1.1

20 State Bank of India 1.95 1.76 1.78 1.6

21 State Bank of Bikaner & Jaipur

1.95 1.34 1.06 1.1

22 State Bank of Hyderabad 14.1 10.7 10.50 0.6

23 State Bank Of Indore 1.12 1.19 9.06 0.9

24 State Bank Of Mysore 1.75 1.42 1.08 0.9

25 State Bank of Patiala 2.05 1.10 0.88 0.8

26 State Bank of Saurashtra 0.95 0.65 0.82 ---

27 State Bank of Travancore 0.95 1.42 0.69 0.9

Findings from the above table:

•We determine the percentage of assets out of total assets / advances that are likely to become

the Non performing Assets as problematic assets.

•From the above table it becomes clear that Central Bank of India, Indian Overseas Bank,

United Bank of India and State Bank of India have the high ratio of 1.6%.

•That Ratio implies that the both above banks have the highest probability of creating NPA’s in

the near future.

81

5 CAPITAL ADEQUACY RATIO

Capital Adequacy Ratio can be defined as ratio of the capital of the Bank, to its assets, which

are weighted/adjusted according to risk attached to them i.e.

Capital Adequacy Ratio = Capital * 100 / Risk Weighted Assets

S.no Name of Bank 2009 2010 2011 2012

1 2 3 4 5 6

Nationalized Bank

1 Allahabad Bank 13.37 12.52 12.04 13.1

2 Andhra Bank 14.00 11.33 11.61 13.2

3 Bank of Baroda 13.65 11.80 12.91 14.1

4 Bank of India 10.75 11.75 12.04 13.0

5 Bank of Maharashtra 11.27 12.06 10.26 12.1

6 Canara Bank 11.22 13.50 13.25 14.1

7 Central Bank of India 11.03 10.40 10.42 13.1

8 Corporation Bank 13.92 12.76 12.09 13.6

9 Dena Bank 10.62 11.52 11.09 12.1

10 Indian Bank 13.19 14.14 12.86 14.6

11 Indian Overseas Bank 13.04 13.27 11.96 13.2

12 Oriental Bank 11.04 12.51 12.12 13.0

13 Punjab & Sind Bank 12.83 12.88 11.57 14.4

14 Punjab National Bank 11.95 12.29 12.96 14.0

15 Sydnicate Bank 11.73 11.74 11.22 12.7

16 UCO Bank 11.12 11.56 10.09 11.9

17 Union Bank of India 11.41 12.80 12.51 13.3

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18 United Bank of India 13.12 12.02 11.88 13.3

19 Vijya Bank 11.94 11.21 11.22 13.2

20 State Bank of India 11.88 12.34 12.64 14.3

21 State Bank of Bikaner & Jaipur 12.08 12.89 12.51 14.5

22 State Bank of Hyderabad 12.08 12.51 12.35 11.5

23 State Bank Of Indore 11.40 11,77 11.29 13.5

24 State Bank Of Mysore 11.37 11.47 11.73 13.4

25 State Bank of Patiala 13.67 12.38 12.50 12.6

26 State Bank of Saurashtra 12.03 12.78 12.34 11.6

27 State Bank of Travancore 11.15 11.68 12.68 14.0

Findings from the above table:

•The capital adequacy ratio is important for them to maintain as per the banking regulations.

•Each bank needs to create the capital Reserve to compensate the Non Performing Assets.

•Each Asset has given a risk weightage as per RBI guidelines

•Risk weighted Asset = Asset * Risk Weightage So, More the Risk weighted Assets are, Bank

has to maintain more capital.

•As far as this ratio is concerned the Indian Bank has shown much appreciated result by

acquiring the ratio of 14.6% followed by the State Bank of Bikaner & Jaipur, Punjab & Sind

Bank having ratios of 14.5% and 14.4% in 2012 .

4.6 SUB-STANDARD ASSETS RATIO

It is the ratio of Total Substandard Assets to Gross NPA of the bank.

Substandard Assets Ratio= total substandard assets /Gross NPAs*100

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It indicates scope of up gradation/improvement in NPA.

Higher substandard asset ratio means that in whole NPA the sub standard ratio has

major proportion, which indicates that there is a high scope for advance up gradation or

improvement because it will be very easy to recover the loan as minimum duration of

default.

4.7 DOUBTFUL ASSET RATIO:

It is the ratio of Total Doubtful Assets to Gross NPAs of the bank.

Doubtful Asset Ratio =Total doubtful assets/Gross NPAs*100

It indicates the scope of compromise for NPA reduction.

4.8 LOSS ASSET RATIO:

It is the ratio of total loss assets to Gross NPA of the bank.

Loss Asset Ratio=Total Loss Assets /Gross NP A* 100

It indicates the proportion of bad loans in the banks.

However if the ratio increases in the recent year, which is detrimental to the bank. The

bank must take necessary steps to control this ratio, as it is the indication that there is

increasing incidence of erosion of securities and fraudulent Loan Accounts in the bank

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FINDINGS, RECOMMENDATION AND CONCLUSION

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1. Gross NPA Ratio for 2012 – Findings

Findings from the above graph:

High gross NPA ratio indicates the low credit portfolio of bank and vice-a-versa.

We can see from the above table that the united bank of India has the higher gross NPA

ratio of 2.9% followed by the State Bank of India & UCO Bank with 2.8 %. Central bank

of India also have higher gross NPA ratio with 2.7% in 2012.

Whereas the Punjab & Sind Bank , Bank of Baroda , Indian bank showed lower ratio with

0.7%, 0.8 % and 0.9% in the year 2012.

In 2010 Central Bank of India have highest Gross NPA ratio of 4.8%.

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1. Net NPA Ratio for 2009 – Findings

Findings from the above graph:

This ratio indicates the degree of risk in the portfolio of the banks. High NPA ratio indicates the high quantity of risky assets in the Banks for which no provision are made.

From the graph it becomes clear that the NPA ratio of almost all the Banks have been improved quite well as compared to the previous year.

The State Bank of India has the highest NPA ratio of 1.8 % followed by the United Bank

of India with 1.5 % & Indian Overseas Bank with 1.3%, Central Bank Of India and UCO

Bank with 1.2% The Andhra Bank has showed the lowest NPA ratio 0.2% and Punjab

National Bank also showed the lowest NPA ratio 0.2%, Bank of Baroda and Bank of

India have also showed lower NPA ratio with 0.3% and 0.4 % in 2012.

In 2010 UCO Bank have highest Net NPA ratio of 2.14%.

2. Provisioning Ratio – Findings

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Findings from the above graph

This Ratio indicates the degree of safety measures adopted by the Banks.

It has direct bearing on the profitability, Dividend and safety of shareholders’ fund.

If the provision ratio is less, it indicates that the Banks has made under provision.

The highest provision ratio is showed by Punjab National Bank India with 88.88%

followed by

Sydnicate Bank with 87.89 % & Union Bank of India in the year 2012.

The lowest provision ratio is showed Canara Bank with only 31.27 % followed by State

Bank of India with 35.71% State Bank of Bikaner & Jaipur With 43.75%

3. Problem Asset Ratio – Findings

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Findings from the above table:

We determine the percentage of assets out of total assets / advances that are likely to

become the Non performing Assets as problematic assets.

From the above table it becomes clear that Central Bank of India, Indian Overseas Bank,

United Bank of India and State Bank of India have the high ratio of 1.6%.

That Ratio implies that the both above banks have the highest probability of creating

NPA’s in the near future.

IN 2010and 2011 State Bank of Hyedrabad have highest problem assets ratio of 10.50%

and 10.7%.

5. Capital Adequacy Ratio - Findings

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Findings from the above table:

The capital adequacy ratio is important for them to maintain as per the banking regulations.

Each bank needs to create the capital Reserve to compensate the Non Performing Assets.

Each Asset has given a risk weightage as per RBI guidelines

Risk weighted Asset = Asset * Risk Weightage So, More the Risk weighted Assets are , Bank has to maintain more capital .

As far as this ratio is concerned the Indian Bank has shown much appreciated result by

acquiring the ratio of 14.6% followed by the State Bank of Bikaner & Jaipur, Punjab &

Sind Bank having ratios of 14.5% and 14.4% in 2012.

Recommendations of the study

Through RBI has introduced number of measures to reduce the problem of increasing

NPAs of the banks such as CDR mechanism. One time settlement schemes, enactment

of SRFAESI act, etc. A lot of measures are desired in terms of effectiveness of these

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measures. What I would like to suggest for reducing the evolutions of the NPAs of Public

Sector Banks are as under.

(1) Each bank should have its own independent credit rating agency which should

evaluate the financial capacity of the borrower before than credit facility.

(2) The credit rating agency should regularly evaluate the financial condition of the

clients.

(3) Special accounts should be made of the clients where monthly loan concentration

reports should be made.

(4) It is also wise for the banks to carryout special investigative audit of all financial and

business transactions and books of accounts of the borrower company when there is

possibility of the diversion of the funds and mismanagement.

(5) The banks before providing the credit facilities to the borrower company should

analyze the major heads of the income and expenditure based on the financial

performance of the comparable companies in the industry to identify significant

variances and seek explanation or the same from the company management. They

should also analyze the current financial position of the major assets and liabilities.

(6) Banks should evaluate the SWOT analysis of the borrowing companies i.e. how they

would face the environmental threats and opportunities with the use of their strength and

weakness and what will be their possible future growth in concerned to financial and

operational performance.

(7) Independent settlement procedure should be more strict and faster and the decision

made by the settlement committee should be binding both borrowers and lenders and

any one of them failing to follow the decision of the settlement committee should be

punished severely

(8) There should be proper monitoring of the restructured accounts because there is every possibility of the loans slipping into NPAs category again.

(9) Proper training is important to the staff of the banks at the appropriate level with ongoing process. That how they should deal the problem of NPAs, and what continues steps they should take to reduce the NPAs.

(10) Willful Default of Bank loans should be made a Criminal Offence.

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(11) No loan is to be given to a Group whose one or the other undertaking has become a Defaulter.

Conclusion of the Study

1. The NPA is one of the biggest problems that the Public Sector Banks are facing today is the

problem of nonperforming assets. If the proper management of the NPAs is not undertaken it

would hamper the business of the banks.

2. In absolute terms, the last three years have seen an increase in the net NPAs of 25 public

sector banks by 24 per cent. According to the numbers, the last year it saw a 17 percent rise in

the sticky assets.

3. The largest public sector lender, SBI, has seen an increase in the net NPAs by a whopping

41 percent in 2010-11.

4. As the global slowdown has crept into the economy, bankers feel that in more loans are going

to turn bad in the coming quarters and therefore they want RBI to relax the deadline for loan

reconstruction.

5. Due to Recession & slowdown in the Indian economy would result in emerging NPA‘s for the

public sector banks from textiles, real estate, retail, exports and auto sectors.

6. The RBI has also been trying to take number of measures but the ratio of NPAs is not

decreasing of the banks. The banks must find out the measures to reduce the evolving problem

of the NPAs.

7. The reduction of the NPAs would help the banks to boost up their profits, smooth recycling of

funds in the nation. This would help the nation to develop more banking branches and

developing the economy by providing the better financial services to the nation.

8. If the concept of NPAs is taken very lightly it would be dangerous for the Indian banking

sector. The NPAs would destroy the current profit, interest income due to large provisions of the

NPAs, and would affect the smooth functioning of the recycling of the funds.

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9. As a result of the NPA’s owners do not receive a market return on their capital . In the worst

case, if the bank fails, owners lose their assets & this may affect a broad pool of shareholders &

act as a rain on Profitability.

10. Banks also redistribute losses to other borrowers by charging higher interest rates .Lower

deposit rates and higher lending rates repress savings and financial markets , which hampers

economic growth .

11. When many borrowers fail to pay interest, banks may experience liquidity shortages .These

shortages can jam payments across the country and as a result non performing loans may spill

over the banking system and contract the money stock, which may lead to economic contraction

12. Banks need to create capital reserve to writeoff the mounting NPA’s burden

13. “A Man without money is like a bird without wings”, the Rumanian proverb insists the

importance of the money. A bank is an establishment, which deals with money. The basic

functions of Commercial banks are the accepting of all kinds of deposits and lending of money.

In general there are several challenges confronting the commercial banks in its day today

operations. The main challenge facing the commercial banks is the disbursement of funds in

quality assets (Loans and Advances) or otherwise it leads to Non-performing assets.”

Limitations of the study

The limitations that I felt in my study are:

It was critical for me to gather the financial data of the every bank of the Public Sector

Banks so the better evaluations of the performance of the banks are not possible.

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Since my study is based on the secondary data, the practical operations as related to

the NPAs are adopted by the banks are not learned.

Since the Indian banking sector is so wide so it was not possible for me to cover all the

banks of the Indian banking sector.

Provision for the classification of the Assets / NPA’s differs within each public sector

bank & this information is not available Publicly.

The RBI norms for the classification of assets / NPA’s are available on a pay site & not

publicly available through any source.

BIBLIOGRAPHY

http://www.equitymaster.com/stockquotes/mystocks.asp

http://moneyterms.co.uk/interest_spread/

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http://economictimes.indiatimes.com/Features/The_Sunday_ET/Economy/Private_banks_struggle_to_manage_their_non-performing_assets/articleshow/3049718.cms#write

www.123eng.com

http://www.rupeetimes.com/experts/joseph_samson_5.html

http://www.rupeetimes.com/news/personal_loan/ banks_ask_rbi_to_relax_npa_norms_for_real_estate_sector_1919.htm

http//:www.rbi.org.com

http//:www.money.radiff.com

http//:www.economictimes.indiatimes.com

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