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MANAGEMENTOFNON-

PERFORMINGASSETS


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DEFIN ITION OF NPAS

A NPA is a loan or an advance where; Interest and/ or installment of principal remain

overdue for a period of more than 90 days inrespect of a term loan,

The account remains out of order in respect ofan overdraft/ cash credit

The bill remains overdue for a period of more than90 days in the case of bills purchased and

discountedThe installment or interest remains overdue for two

crop seasons in case of short duration crops andfor one crop season in case of long duration crops

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CATEGORIES OF NPA

Substandard Assets Which has remainedNPA for a period less than or equal to 12months.

Doubtful Assets Which has remained inthe sub-standard category for a period of12 months

Loss Assets where loss has beenidentified by the bank or internal or externalauditors or the RBI inspection but theamount has not been written off wholly.

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PROVISIONING NORMS

Standard Assets general provision of aminimum of 0.25%

Substandard Assets 10% on total outstandingbalance, 10 % on unsecured exposures identifiedas sub-standard & 100% for unsecureddoubtful assets.

Doubtful Assets 100% to the extent advance notcovered by realizable value of security. In case of

secured portion, provision may be made in therange of 20% to 100% depending on the period ofasset remaining sub-standard

Loss Assets 100% of the outstanding4


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FACTORS CONTRIBUTING TO

NPAS Poor Credit discipline Inadequate Credit & Risk Management

Diversion of funds by promoters

Funding of non-viable projects

In the early 1990s PSBs started suffering fromacute capital inadequacy and lower/ negativeprofitability. The parameters set for their

functioning did not project the paramount need forthese corporate goals.

The banks had little freedom to price products,cater products to chosen segments or investfunds in their best interest 5


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NPAS

Since 1970s, the SCBs functioned as units cut offfrom international banking and unable toparticipate in the structural transformations andnew types of lending products.

Audit and control functions were not independentand thus unable to correct the effect of seriousflaws in policies and directions

Banks were not sufficiently developed in terms of

skills and expertise to regulate the humongousgrowth in credit and manage the diverse risks thatemerged in the process

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NPAS

Inadequate mechanism to gather and disseminatecredit information amongst commercial banks

Effective recovery from defaulting and overdueborrowers was hampered on account of sizeableoverhang component arising from infirmities in theexisting process of debt recovery, inadequatelegal provisions on foreclosure and bankruptcyand difficulties in the execution of court decrees.

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IMPACT OF NPAS ON

OPERATIONS

Drain on Profitability Impact on capital adequacy

Adverse effect on credit growth as thebankers prime focus becomes zero percentrisk and as a result turn lukewarm to freshcredit.

Excessive focus on Credit Risk Management High cost of funds due to NPAs

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STATU S OF NPAS 2005 -06

All SCBs average Net NPA Ratio for 2005-06 is1.22 (As per RBIs Statistics)

The banks have been able to report lower NPApercentage mostly by providing against or writingoff NPAs.

The provision to certain extent was facilitated byhigher profits on account of treasury management

The better Net NPA ratio was also facilitated byhigher credit off take resulting in larger assetportfolio/ book size.

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NPA MANAGEMENT PREVENTIVEMEASURES Formation of the Credit Information Bureau

(India) Limited (CIBIL) Release of Wilful Defaulters List. RBI also

releases a list of borrowers with aggregateoutstanding of Rs.1 crore and above againstwhom banks have filed suits for recovery oftheir funds

Reporting of Frauds to RBI

Norms of Lenders Liability framing of FairPractices Code with regard to lenders liabilityto be followed by banks, which indirectlyprevents accounts turning into NPAs onaccount of banks own failure

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NPA MANAGEMENT PREVENTIVEMEASURES Risk assessment and Risk management

RBI has advised banks to examine all cases ofwilful default of Rs.1 crore and above and filesuits in such cases. Board of Directors arerequired to review NPA accounts of Rs.1 croreand above with special reference to fixing ofstaff accountability.

Reporting quick mortality cases

Special mention accounts for earlyidentification of bad debts. Loans andadvances overdue for less than one and twoquarters would come under this category.However, these accounts do not needprovisioning

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NPA MANAGEMENT -

RESOLUTION

Compromise Settlement Schemes Restructuring / Reschedulement Lok Adalat Corporate Debt Restructuring Cell Debt Recovery Tribunal (DRT) Proceedings under the Code of Civil Procedure Board for Industrial & Financial Reconstruction

(BIFR)/ AAIFR

National Company Law Tribunal (NCLT) Sale of NPA to other banks Sale of NPA to ARC/ SC under Securitization and

Reconstruction of Financial Assets and Enforcementof Security Interest Act 2002 (SRFAESI)

Liquidation 12


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Com promise Set t lem entSchemes

Banks are free to design and implementtheir own policies for recovery and writeoff incorporation compromise andnegotiated settlements with boardapproval

Specific guidelines were issued in May1999 for one time settlement of smallenterprise sector.

Guidelines were modified in July 2000for recovery of NPAs of Rs.5 crore andless as on 31st March 2007. 13


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Rest ruc t u r ing and Rehab i l i t a t ion

Banks are free to design and implementtheir own policies for restructuring/rehabilitation of the NPA accounts

Reschedulement of payment of interestand principal after considering the Debtservice coverage ratio, contribution ofthe promoter and availability of security

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Lok Adala t s

Small NPAs up to Rs.20 Lacs Speedy Recovery

Veil of Authority

Soft Defaulters

Less expensive

Easier way to resolve

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Corporat e DebtRest ruc tu r ing

The objective of CDR is to ensure a timely and transparentmechanism for restructuring of the debts of viablecorporate entities affected by internal and external factors,outside the purview of BIFR, DRT or other legalproceedings

The legal basis for the mechanism is provided by the Inter-Creditor Agreement (ICA). All participants in the CDRmechanism must enter the ICA with necessaryenforcement and penal clauses.

The scheme applies to accounts having multiple banking/syndication/ consortium accounts with outstandingexposure of Rs.10 crores and above.

The CDR system is applicable to standard and sub-standard accounts with potential cases of NPAs getting apriority.

Packages given to borrowers are modified time & again Drawback of CDR Reaching of consensus amongst the

creditors delays the process

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DRT Ac t The banks and FIs can enforce their securities by initiating

recovery proceeding under the Recovery if Debts due toBanks and FI act, 1993 (DRT Act) by filing an applicationfor recovery of dues before the Debt Recovery Tribunalconstituted under the Act.

On adjudication, a recovery certificate is issued and thesale is carried out by an auctioneer or a receiver.

DRT has powers to grant injunctions against the disposal,transfer or creation of third party interest by debtors in theproperties charged to creditor and to pass attachmentorders in respect of charged properties

In case of non-realization of the decreed amount by way ofsale of the charged properties, the personal properties ifthe guarantors can also be attached and sold.

However, realization is usually time-consuming Steps have been taken to create additional benches

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Proc eeding under Code of Civ i l

Procedure

For claims below Rs.10 lacs, the banks and FIs can initiateproceedings under the Code of Civil Procedure of 1908, asamended, in a Civil court.

The courts are empowered to pass injunction ordersrestraining the debtor through itself or through itsdirectors, representatives, etc from disposing of, partingwith or dealing in any manner with the subject property.

Courts are also empowered to pass attachment and salesorders for subject property before judgment, in casenecessary.

The sale of subject property is normally carried out by wayof open public auction subject to confirmation of thecourt.

The foreclosure proceedings, where the DRT Act is notapplicable, can be initiated under the Transfer of PropertyAct of 1882 by filing a mortgage suit where the procedureis same as laid down under the CPC.

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BIFR AND AAIFR BIFR has been given the power to consider revival and

rehabilitation of companies under the Sick IndustrialCompanies (Special Provisions) Act of 1985 (SICA),which has been repealed by passing of the SickIndustrial Companies (Special Provisions) Repeal Bill of2001.

The board of Directors shall make a reference to BIFRwithin sixty days from the date of finalization of the dulyaudited accounts for the financial year at the end ofwhich the company becomes sick

The company making reference to BIFR to prepare ascheme for its revival and rehabilitation and submit thesame to BIFR the procedure is same as laid down underthe CPC.

The shelter of BIFR misused by defaulting anddishonest borrowers

It is a time consuming process19


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NATIONAL COMPANY LAW

TRIBUNAL In December 2002, the Indian Parliament passed the

Companies Act of 2002 (Second Amendment) torestructure the Companies Act, 1956 leading to a newregime of tackling corporate rescue and insolvency andsetting up of NCLT.

NCLT will abolish SICA, have the jurisdiction and powerrelating to winding up of companies presently vested inthe High Court and jurisdiction and power exercised byCompany Law Board

The second amendments seeks to improve upon thestandards to be adopted to measure the competence,performance and services of a bankruptcy court byproviding specialized qualification for the appointment ofmembers to the NCLT.

However, the quality and skills of judges, newly appointedor existing, will need to be reinforced and no provision hasbeen made for appropriate procedures to evaluate theperformance of judges based on the standards

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SALE OF NPA TO OTHER BA NK S A NPA is eligible for sale to other banks only if it has

remained a NPA for at least two years in the books of theselling bank The NPA must be held by the purchasing bank at least for

a period of 15 months before it is sold to other banks butnot to bank, which originally sold the NPA.

The NPA may be classified as standard in the books of thepurchasing bank for a period of 90 days from date ofpurchase and thereafter it would depend on the record ofrecovery with reference to cash flows estimated whilepurchasing

The bank may purchase/ sell NPA only on withoutrecourse basis If the sale is conducted below the net book value, the

short fall should be debited to P&L account and if it ishigher, the excess provision will be utilized to meet theloss on account of sale of other NPA.

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SARFESI Ac t 2002 SARFESI provides for enforcement of security

interests in movable (tangible or intangible assetsincluding accounts receivable) and immovableproperty without the intervention of the court

The bank and FI may call upon the borrower by way ofa written legal notice to discharge in full his liabilitieswithin 60 days from the date of notice, failing whichthe bank would be entitled to exercise all or any of therights set out under the Act.

Another option available under the Act is to takeoverthe management of the secured assets

Any person aggrieved by the measures taken by thebank can proffer an appeal to DRT within 45 daysafter depositing 75% of the amount claimed in thenotice.

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SARFESI Ac t 2002 Chapter II of SARFESI provides for setting up of

reconstruction and securitization companies foracquisition of financial assets from its owner, whetherby raising funds by such company from qualifiedinstitutional buyers by issue of security receiptsrepresenting undivided interest in such assets orotherwise.

The ARC can takeover the management of thebusiness of the borrower, sale or lease of a part orwhole of the business of the borrower andrescheduling of payments, enforcement of security

interest, settlement of dues payable by the borroweror take possession of secured assets

Additionally, ARCs can act as agents for recoveringdues, as manager and receiver.

Drawback differentiation between first chargeholders and the second charge holders

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Whet her Sec ondAm endm ent t o Com paniesAc t and SARFESI Providee ffec t i ve and c ompa t ibleen fo rcement

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Sec ond Am endm ent &

SARFESI

The second amendment and SARFESI are aleap forward but requirement exists to makethe laws predictable, transparent andaffordable enforcement by efficientmechanisms outside of insolvency

No definite time frame has been provided forvarious stages during the liquidation

proceedings Need is felt for more creative and commercial

approach to corporate entities in financialdistress and attempts to revive rather thanapplying conservative approach of liquidation25


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SARFESI

Tribunals have largely failed to serve thepurpose for which they were set up.NCLT(National Co. Law Tribunal) wouldbe over-burdened with workload. Changein eligibility criteria for making areference would itself generate a greater

workload. The second amendment stops short ofproviding a comprehensive bankruptcycode to deal with corporate bankruptcy.

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SARFESI

Does not introduce the required roadmap ofthe bankruptcy proceeding viz: Application for initiating

Appointments & empowerment of trustee

Operational and functional independence

Accountability to court

Monitoring and time bound restructuring

Mechanism to sell off

Number of time bound attempts for restructuring Decision to pursue insolvency and winding up

Strategies for realization and distribution

Need for new laws & procedures to handlebankruptcy proceedings in consultation withRBI

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NEGOTIATION PROCESSFOR SETTLEMENT OF

NON PERFORMINGASSETS

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Fac t o rs A f fec t ing t he Ac c ep tance

of Proposal by B ank Banks Documentation. Security value. Realizable sale value. Banks ability to sell. Ability & Source of the borrower. Ability & Source of the guarantor. Vulnerability of the borrower/guarantor. Time frame.

Strength and Zeal of bank's field staff. What message is bank sending out (No in a fraud

case.) Banks Policy. Success rate.

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Preparat ion St age Thorough study of the case

Find out our strengths and weaknesses in thecase.

Find out the vulnerable point/weaknesses ofthe borrower.

Follow-up with the Borrower and Guarantors.

Visit factory/Collaterals/residence.

Find out properties not charged to the bank.

Indicate that Bank is willing to compromise.

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ROLE OF CHARTEREDACCOUNTANTS Assist and Prepare Viability study

Conduct Business, Assets & Share Valuation Carry out Due Diligence Study for Business

Restructuring

Verification and Vetting of Documents

Preparation of Scheme of Arrangement

Consultancy on Taxation aspects

Monitoring of Accounts Credit Audit of borrowers

Stock Audits

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