CHAPTERIZATION

CHAPTERIZATION

Chapter 1

1. INTRODUCTION

1.1 INDIAN BANKING INDUSTRY

1.2 IMPORTANCE OF NPA MANAGEMENT

1.3 OBJECTIVE

1.4 LEITERATURE REVIEW

1.5 RESEARCH DESIGN

Chapter 2

2. DIFFERENT TOOLS AND GUIDELINES USED TO REDUCE NPAs.

2.1 TYPES OF NPAS

2.2 ASSET CLASSIFICATION

2.3 IMPACT OF NPA

Chapter 3

3. TECHNIQUES USED FOR MANAGEMENT OF NPAs

3.1 EARLY SYMYOMS

3.2 REASONS FOR AN ACCOUNT BECOMING NPA

3.3 PREVENTIVE MEASUREMENT FOR NPA

3.4 PROCEDURES FOR NPA IDENTIFICATION AND RESOLUTION IN INDIA

Chapter 4

4. COMPOSITIONS OF NPAs OF BANK SECTOR WISE

4.1 FINDINGS AND ANALYSIS

4.2 CONCLUSION

REFERENCE BIBLIOGRAPHY / WEBLIOGRAPHY

INTRODUCTION TO NPAMEANING OF NPA:

Non Performing Asset means an asset or account of 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 classification issued by RBI.

An amount due under any credit facility is treated as "past due" when it has not been paid within 30 days from the due date. Due to the improvement in the payment and settlement systems, recovery climate, up gradation of technology in the banking system, etc., it was decided to dispense with 'past due' concept, with effect from March 31, 2001. Accordingly, as from that date, a Non performing asset (NPA) shell be an advance where

i. Interest and /or installment of principal remain overdue for a period of more than 180days in respect of a Term Loan

ii. The account remains 'out of order' for a period of more than 180 days, in respect of an overdraft/ cash Credit (OD/CC),

iii. The bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted

iv. Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, And

v. Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.

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) shell be a loan or an advance where;

i. Interest and /or installment of principal remain overdue for a period of more than 90days in respect of a Term Loan,

ii. The account remains 'out of order' for a period of more than 90 days, in respect of an overdraft/ cash Credit(OD/CC),

iii. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,

iv. Interest and/ or installment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purpose, and

v. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts

1.1 INDIAN BANKING INDUSTRYINTRODUCTION:

Banking in India originated in the last decades of the 18th century. The oldest bank inexistence in India is the State Bank of India, a government-owned bank that traces its origins back to June 1806 and that is the largest commercial bank in the country. Central banking is the responsibility of the Reserve Bank of India, which in 1935 formally took over these responsibilities from the then Imperial Bank of India, relegating it to commercial banking functions.

After India's independence in 1947, the Reserve Bank was nationalized and given broader powers. In 1969 the government nationalized the 14 largest commercial banks; the government nationalized the six next largest in 1980.Currently, India has 96 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the Government of India holding a stake), 31 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 38 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75percent of total assets of the banking industry, with the private and foreign banks holding18.2% and 6.5% respectively

EARLY HISTORY:

Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India which started in 1786, and the Bank of Hindustan, both of which are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. For many years the Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in 1921 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of India.

Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865and still functioning today, is the oldest Joint Stock bank in India. It was not the first though. That honor belongs to the Bank of Upper India, which was established in 1863, and which survived until 1913, when it failed, with some of its assets and liabilities being transferred to the Alliance Bank of Simla. When the American Civil War stopped the supply of cotton to Lancashire from the Confederate States, promoters opened banks to finance trading in Indian cotton. With large exposure to speculative ventures, most of the banks opened in India during that period failed. The depositors lost money and lost interest in keeping deposits with banks. Subsequently, banking in India remained the exclusive domain of Europeans for next several decades until the beginning of the 20th century.

Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoired'Escompte de Paris opened a branch in Calcutta in 1860 and another in Bombay in 1862; branches in Madras and Pondicherry, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta was the most active trading port in India, mainly due to the trade of the British Empire, and so became a banking center.

The Bank of Bengal, which later became the State Bank of India, the first entirely Indian joint stock bank was the Oudh Commercial Bank, established in1881 in Faridabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which has survived to the present and is now one of the largest banks in India. Around the turn of the 20th Century, the Indian economy was passing through a relative period of stability. Around five decades had elapsed since the Indian Mutiny, and the social, industrial and other infrastructure had improved. Indians had established small banks, most of which served particular ethnic and religious communities

. The presidency banks dominated banking in India but there were also some exchange banks and a number of Indian joint stock banks. All these banks operated in different segments of the economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian joint stock banks were generally undercapitalized and lacked the experience and maturity to compete with the presidency and exchange banks. This segmentation let Lord Curzon to observe, "In respect of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome compartments."The period between 1906 and 1911, saw the establishment of banks inspired by the Swedish movement.

The Swedish movement inspired local businessmen and political figures to found banks of and for the Indian community. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of Baroda, Canara Bank and Central Bank of India. The fervor of Swedish movement lead to establishing of many private banks in Dakshina Kannada and Udupi district which were unified earlier and known by the name South Kanara( South Kanara ) district. Four nationalized banks started in this district and also a leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of Indian Banking".

FROM WORLD WAR I TO INDEPENDENCE:

The period during the First World War (1914-1918) through the end of the Second World War (1939-1945), and two years thereafter until the independence of India were challenging for Indian banking. The years of the First World War were turbulent, and it took its toll with banks simply collapsing despite the Indian economy gaining indirect boost due to war-related economic activities. At least 94 banks in India failed between 1913 and 1918 as indicated in the following table:

Post-independence

The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal, paralyzing banking activities for months. India's independence marked the end of a regime of the Laissez-faire for the Indian banking. The Government of India initiated measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed economy. This resulted in to greater involvement of the state in different segments of the economy including banking and finance.

The major steps to regulate banking included: In 1948, the Reserve Bank of India, India's central banking authority, was

nationalized, and it became an institution owned by the Government of India. In 1949, the Banking Regulation Act was enacted which empowered the Reserve

Bank of India (RBI) "to regulate, control, and inspect the banks in India." The Banking Regulation Act also provided that no new bank or branch of an existing

bank could be opened without a license from the RBI, and no two banks could have common directors.

However, despite these provisions, control and regulations, banks in India except the State Bank of India, continued to be owned and operated by private persons. This changed with the nationalization of major banks in India on 19 July 1969.

NationalizationBy the 1960s, the Indian banking industry had become an important tool to facilitate the development of the Indian economy. At the same time, it had emerged as a large employer, and a debate had ensued about the possibility to nationalize the banking industry. Indira Gandhi, the-then Prime Minister of India expressed the intention of the GOI in the annual conference of the All India Congress Meeting in a paper entitled "Stray thoughts on Bank Nationalization." The paper was received with positive enthusiasm. Thereafter, her move was swift and sudden, and the GOI issued an ordinance and nationalized the 14 largest commercial banks with effect from the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of India, described the step as a "masterstroke of political sagacity." Within two weeks of the issue of the ordinance, the Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking)Bill, and it received the presidential approval on 9 August 1969.A second dose of nationalization of 6 more commercial banks followed in 1980.

The stated reason for the nationalization was to give the government more control of credit delivery. With the second dose of nationalization, the GOI controlled around 91% of the banking business of India. Later on, in the year 1993, the government merged New Bank of India with Punjab National Bank. It was the only merger between nationalized banks and resulted in the reduction of the number of nationalized banks from 20 to 19. After this, until the 1990s, the nationalized banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy. The nationalized banks were credited by some; including Home minister P. Chidambaram, to have helped the Indian economy withstand the global financial crisis of 2007-2009.

LiberalizationIn the early 1990s, the then Narsimha Rao government embarked on a policy of liberalization, licensing a small number of private banks. These came to be known as New Generation tech-savvy banks, and included Global Trust Bank (the first of such new generation banks to be set up), which later amalgamated with Oriental Bank of Commerce, Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, revitalized the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks.

The next stage for the Indian banking has been setup with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%, at present it has gone up to 74%with some restrictions. The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4-6-4 method (Borrow at 4%; Lend at 6%; Go home at 4) of functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks. All this led to the retail boom in India. People not just demanded more from their banks but also received more. Currently (2007), banking in India is generally fairly mature in terms of supply, product range and reach-even though reach in rural India still remains a challenge for the private sector and foreign banks.

In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate-and this has mostly been true. With the growth in the Indian economy expected to be strong for quite some time-especially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong. One may also expect M&A s, takeovers, and asset sales. In March 2006, the Reserve Bank of India allowed Warburg Pinc us to increase its stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an investor has been allowed to hold more than 5% in a private sector bank since the RBI announced norms in 2005 that any stake exceeding 5% in the private sector banks would need to be vetted by them.

In recent years critics have charged that the non-government owned banks are too aggressive in their loan recovery efforts in connection with housing, vehicle and personal loans. There are press reports that the banks' loan recovery efforts have driven defaulting borrowers to suicide.

RECENT HISTORY OF INDIAN BANKING: Indian banking system, over the years has gone through various phases after establishment of Reserve Bank of India in 1935 during the British rule, to function as Central Bank of the country. Earlier to creation of RBI, the central bank functions were being looked after by the Imperial Bank of India.

With the 5-year plan having acquired an important place after the independence, the Govt. felt that the private banks may not extend the kind of cooperation in providing credit support, the economy may need. In 1954 the All India Rural Credit Survey Committee submitted its report recommending creation of a strong, integrated, State-sponsored, State-partnered commercial banking institution with an effective machinery of branches spread all over the country.

The recommendations of this committee led to establishment of first Public Sector Bank in the name of State Bank of India on July 01, 1955by acquiring the substantial part of share capital by RBI, of the then Imperial Bank of India. Similarly during 1956-59, as a result of re-organization of princely States, the associate banks came into fold of public sector banking.

Another evaluation of the banking in India was undertaken during 1966 as the private banks were still not extending the required support in the form of credit disbursal, more particularly to the unorganized sector. Each leading industrial house in the country at that time was closely associated with the promotion and control of one or more banking companies. The bulk of the deposits collected, were being deployed in organized sectors of industry and trade, while the farmers, small entrepreneurs, transporters , professionals and self-employed had to depend on money lenders who used to exploit them by charging higher interest rates.

In February 1966, a Scheme of Social Control was set-up whose main function was to periodically assess the demand for bank credit from various sectors of the economy to determine the priorities for grant of loans and advances so as to ensure optimum and efficienttilisation of resources.

The scheme however, did not provide any remedy. Though a no. of branches were opened in rural area but the lending activities of the private banks were not oriented towards meeting the credit requirements of the priority/weaker sectors.

On July 19, 1969, the Govt. promulgated Banking Companies (Acquisition and Transfer of Undertakings) Ordinance 1969 to acquire 14 bigger commercial bank with paid up capital of Rs.28.5 cr, deposits of Rs.2629 cr, loans of Rs.1813 cr and with 4134 branches accounting for 80% of advances. Subsequently in 1980, 6 more banks were nationalised which brought91% of the deposits and 84% of the advances in Public Sector Banking.

During December1969, RBI introduced the Lead Bank Scheme on the recommendations of FK Nariman Committee. Meanwhile, during 1962 Deposit Insurance Corporation was established to provide insurance cover to the depositors. In the post-nationalization period, there was substantial increase in the no. of branches opened in rural/semi-urban centre’s bringing down the population per bank branch to 12000appx. During 1976, RRBs were established (on the recommendations of M. Narasimham Committee report) under the sponsorship and support of public sector banks as the 3rdcomponent of multi-agency credit system for agriculture and rural development.

The Service Area Approach was introduced during 1989.While the 1970s and 1980s saw the high growth rate of branch banking net-work, the consolidation phase started in late 80s and more particularly during early 90s, with the submission of report by the Narasimham Committee on Reforms in Financial Services Sector during 1991.In these five decades since independence, banking in India has evolved through four distinct phases:

Foundation phase can be considered to cover 1950s and 1960s till the nationalization of banks in 1969. The focus during this period was to lay the foundation for a sound banking system in the country. As a result the phase witnessed the development of necessary legislative framework for facilitating re-organization and consolidation of the banking system, for meeting the requirement of Indian economy. A major development was transformation of Imperial Bank of India into State Bank of India in 1955 and nationalization of 14 major private banks during 1969.

Expansion phase had begun in mid-60s but gained momentum after nationalization of banks and continued till 1984. A determined effort was made to make banking facilities available to the masses. Branch network of the banks was widened at a very fast pace covering the rural and semi-urban population, which had no access to banking hitherto. Most importantly, credit flows were guided towards the priority sectors. However this weakened the lines of supervision and affected the quality of assets of banks and pressurized their profitability and brought competitive efficiency of the system at low ebb.

Consolidation phase: The phase started in 1985 when a series of policy initiatives were taken by RBI which saw marked slowdown in the branch expansion. Attention was paid to improving house-keeping, customer service, credit management, staff productivity and profitability of banks. Measures were also taken to reduce the structural constraints that obstructed the growth of money market.

Reforms phase:The macro-economic crisis faced by the country in 1991 paved the way for extensive financial sector reforms which brought deregulation of interest rates, more competition, technological changes, prudential guidelines on asset classification and income recognition, capital adequacy, autonomy packages etc.

BANKING IN INDIA: 2009-10

The Indian banking system is financially stable and resilient to the shocks that may arise due to higher non-performing assets (NPAs) and the global economic crisis, according to a stress test done by the Reserve Bank of India (RBI).Significantly, the RBI has the tenth largest gold reserves in the world after spending US$ 6.7billion towards the purchase of 200 metric tons of gold from the International Monetary Fund (IMF) in November 2009.

The purchase has increased the country's share of gold holdings in its foreign exchange reserves from approximately 4 per cent to about 6 per cent. Following the financial crisis, new deposits have gravitated towards public sector banks. According to RBI's 'Quarterly Statistics on Deposits and Credit of Scheduled Commercial Banks: September 2009', nationalized banks, as a group, accounted for 50.5 per cent of the aggregate deposits, while State Bank of India (SBI) and its associates accounted for 23.8 percent.

The share of other scheduled commercial banks, foreign banks and regional rural banks in aggregate deposits were 17.8 per cent, 5.6 per cent and 3.0 per cent, respectively. With respect to gross bank credit also, nationalized banks hold the highest share of 50.5 percent in the total bank credit, with SBI and its associates at 23.7 per cent and other scheduled commercial banks at 17.8 per cent. Foreign banks and regional rural banks had a share of 5.5per cent and 2.5 per cent respectively in the total bank credit.

The report also found that scheduled commercial banks served 34,709 banked centers. Of these centers, 28,095 were single office centers and 64 centers had 100 or more bank offices. The confidence of non-resident Indians (NRIs) in the Indian economy is reviving again. NRI fund inflows increased since April 2009 and touched US$ 45.5 billion on July 2009, as per the RBI's February bulletin. Most of this has come through Foreign Currency Non-resident (FCNR) accounts and Non-resident External Rupee Accounts. India's foreign exchange reserves rose to US$ 284.26 billion as on January 8, 2010, according to the RBI's February bulletin.

INDUSTRY ANALYSIS

S.W.O.T. ANALYSIS OF INDIAN BANKING INDUSTRY:

1. STRENGTH

Indian banks have compared favorably on growth, asset quality and profitability with other regional banks over the last few years. The banking index has grown at a compounded annual rate of over 51 per cent since April 2001 as compared to a 27percent growth in the market index for the same period.

Policy makers have made some notable changes in policy and regulation to help strengthen the sector. These changes include strengthening prudential norms, enhancing the payments system and integrating regulations between commercial and co-operative banks.

Bank lending has been a significant driver of GDP growth and employment.

The vast networking & growing number of branches & ATMs. Indian banking system has reached even to the remote corners of the country.

The government's regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major private banks of India.

In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks incomparable economies in its region.

India has 88 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the Government of India holding a stake)after merger of New Bank of India in Punjab National Bank in 1993, 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks.

They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks holdover 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.

Foreign banks will have the opportunity to own up to 74 per cent of Indian private sector banks and 20 per cent of government owned banks.

WEAKNESS

PSBs need to fundamentally strengthen institutional skill levels especially in sales and marketing, service operations, risk management and the overall organizational performance ethic & strengthen human capital.

Old private sector banks also have the need to fundamentally strengthen skill levels.

The cost of intermediation remains high and bank penetration is limited to only a few customer segments and geographies.

Structural weaknesses such as a fragmented industry structure, restrictions on capital availability and deployment, lack of institutional support infrastructure, restrictive labour laws, weak corporate governance and ineffective regulations beyond Scheduled Commercial Banks (SCBs), unless industry utilities and service bureaus.

Refusal to dilute stake in PSU banks: The government has refused to dilute its stake in PSU banks below 51% thus choking the headroom available to these banks for raining equity capital.

Impediments in sectorial reforms: Opposition from Left and resultant cautious approach from the North Block in terms of approving merger of PSU banks may hamper their growth prospects in the medium term.

OPPORTUNITY

The market is seeing discontinuous growth driven by new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side, and in fee-based income and investment banking on the wholesale banking side. These require new skills in sales & marketing, credit and operations.

Banks will no longer enjoy windfall treasury gains that the decade-long secular decline in interest rates provided. This will expose the weaker banks.

With increased interest in India, competition from foreign banks will only intensify.

Given the demographic shifts resulting from changes in age profile and household income, consumers will increasingly demand enhanced institutional capabilities and service levels from banks.

New private banks could reach the next level of their growth in the Indian banking sector by continuing to innovate and develop differentiated business models to profitably serve segments like the rural/low income and affluent/HNI segments; actively adopting acquisitions as a means to grow and reaching the next level of performance in their service platforms. Attracting, developing and retaining more leadership capacity

Foreign banks committed to making a play in India will need to adopt alternative approaches to win the “race for the customer” and build a value-creating customer franchise in advance of regulations potentially opening up post 2009. At the same time, they should stay in the game for potential acquisition opportunities as and when they appear in the near term. Maintaining a fundamentally long-term value-creation mindset.

Reach in rural India for the private sector and foreign banks.

With the growth in the Indian economy expected to be strong for quite some time especially in its services sector-the demand for banking services, especially retail banking, mortgages and investment services are expected to be strong.

The Reserve Bank of India (RBI) has approved a proposal from the government to amend the Banking Regulation Act to permit banks to trade in commodities and commodity derivatives.

Liberalization of ECB norms: The government also liberalized the ECB norms to permit financial sector entities engaged in infrastructure funding to raise ECBs. This enabled banks and financial institutions, which were earlier not permitted to raise such funds, explore this route for raising cheaper funds in the overseas markets.

In an attempt to relieve banks of their capital crunch, the RBI has allowed them to raise perpetual bonds and other hybrid capital securities to shore up their capital. If the new instruments find takers, it would help PSU banks, left with little head room for raising equity. Significantly, FII and NRI investment limits in these securities have been fixed at 49%, compared to 20% foreign equity holding allowed in PSU banks.

THREATS

Threat of stability of the system: failure of some weak banks has often threatened the stability of the system.

Rise in inflation figures which would lead to increase in interest rates.

Increase in the number of foreign players would pose a threat to the PSB as well asthe private players.

PEST ANALYSIS OF INDIAN BANKING INDUSTRY:

PEST analysis of any industry investigates the important factors that affect the industry and influence the companies operating in the sector. PEST stands for Political, Economic, Social and Technological analysis. The PEST Analysis is a tool to analyze the forces that drive the industry and how those factors can influence the industry.

POLITICAL FACTORS

Government and RBI policies affect the banking sector. Sometimes looking into the political advantage of a particular party, the Government declares some measures to their benefits like waiver of short-term agricultural loans, to attract the farmer’s votes. By doing so, the profits of the bank get affected. Various banks in the cooperative sector are open and run by the politicians. They exploit these banks for their benefits. Sometimes the government appoints various chairmen of the banks. Various policies are framed by the RBI looking at the present situation of the country for better control over the banks.

FOCUS ON REGULATIONS OF GOVERNMENT: Banking is least affected as compare to other developed economy which is attributed to Reserve Bank of India for its robust policy framework, stricter prudential regulations with respect to capital and liquidity. This gives India an advantage in terms of credibility over other countries. Government affects the performance of banking sector most by legislature and framing policy government through its budget affects the banking activities securitization act has given more power to banking sector against defaulting borrowers.

MONETARY POLICY: Monetary Policy 2009-2010Bank Rate: The Bank Rate has been retained unchanged at 6.0%.Repo Rate It has been reduced under the Liquidity Adjustment Facility (LAF) by 25 basis points from 5.0% to 4.75% with immediate effect. Reverse Repo Rate: It has been reduced under LAF by 25 basis points from 3.5% to3.25% with immediate effect. RBI has retained the option to conduct overnight or longer term repo/reverse repo under the LAF depending on market conditions and other relevant factors. Cash Reserve Ratio: CRR has been retained unchanged at 5.0% of NDTL.

FDI LIMIT: The move to increase Foreign Direct Investment FDI limits to 49 percent from 20 percent during the first quarter of this fiscal came as a welcome announcement to foreign players wanting to get a foot hold in the Indian Markets by investing in willing Indian partners who are starved of net worth to meet CAR norms. Ceiling for FII investment in companies was also increased from 24.0 percent to 49.0 percent and have been included within the ambit of FDI investment

BUDGET MEASURES: Budget Provisions:-

1. Increase Farm Credit:The FM has further increase the farm credit target for 2009-10 at Rs 325000 crore compared to Rs 287000 crore targeted in 2008-09.

2. Subvention of 1% to be paid as incentive to farmers: The Budget continued the Interest subvention scheme for short-term crop loans up to Rs 300000 per farmer at the interest rate of 7% per annum. Also additional subvention of 1% to be paid from this year, as incentive to those farmers who repay short-term crop loans on schedule. Also additional allocation of Rs 411 crore over Interim Budget 2009-10 was made for the same.

3. Debt Waiver for Farmers: The Union Budget 2009-10 extended the debt waiver scheme by six more months for farmers owing more than 2 hectare of land. The Union Budget 2008-09 allowed these farmers 25% rebate on loan if they repay 75%of their overdue within stipulated period of 30th June 2009. Currently this facility has been extended from 30th June, 2009 to 31st December, 2009.

Setting up of separate task force for those not covered under the debt waiver scheme:

The government also announced that it will set up a task force to examine the issue of debt taken by a large number of farmers in some regions of Maharashtra from private money lenders who were not covered by the loan waiver scheme announced last year.

OTHER PROVISIONS1. The threshold for non-promoter public shareholding for all listed

companies to be raised in a phased manner.2. To allow scheduled commercial banks setting up off-site ATMs without

prior approval subject to reporting.3. To provide banking facilities in under-banked/un-banked areas in the

next three years. A sub-committee of State level Bankers Committee (SLBC) would identify and formulate an action plan for the same.

4. The Ministry has also granted Rs 100 crore of grants in aid to ensure provision of at least one Centre/Point of Sales (POS) for banking services in each of the un-banked blocks.

BUDGET IMPACT: The Union Budget 2008-09 has focused on farm credit. The agriculture sector has recorded a growth of about 4% per annum with substantial increase in plan allocations and capital formation in the sector. The one-time bank loan waiver of nearly Rs 71000crore (Rs 710 billion) to cover an estimated 40 million farmers was one of the major highlights of the last Budget. This Union Budget has provided further six months extension of 25% rebate on loan for farmers owing more than 2 hectare of land. With Government bearing this burden, banks would not be affected much. It will only help banks to clear their most stubborn NPA accounts on banks book. Moreover the emphasize on hiking promoter shareholding in Public sector banks, expanding network with ATM's, opening of banking centre in un-banked blocks are some of the positive moves for the sector

On the flipside, the spike in government borrowings is set to adversely affect the treasury income of banks in general and public sector banks in particular, through rise in yields on government securities.

OUTLOOK: The Union Budget 2009-10 has not granted much of new grants/stimulus to the banking sector as a whole. However it has increased the Government borrowing to Rs 451093crore (Rs 4510.93 billion) compared to Rs 361782 crore (Rs 3617.82 billion) targeted in the Interim Budget 2009-10.This is likely to push the Bond yields high moving forward. Despite ample liquidity in the system, the 10 year benchmark yield has zoomed above 7% levels owing to rise in borrowing target. Hardening of yields is likely to affect treasury profits of banks in general and Public sector banks in particular.

ECONOMIC FACTORS

Banking is as old as authentic history and the modern commercial banking are traceable to ancient times. In India, banking has existed in one form or the other from time to time. The present era in banking may be taken to have commenced with establishment of bank of Bengal in 1809 under the government charter and with government participation in share capital. Allahabad bank was started in the year 1865 and Punjab national bank in1895, and thus, others followed. Every year RBI declares its 6 monthly policy and accordingly the various measures and rates are implemented which has an impact on the banking sector. Also the Union budget affects the banking sector to boost the economy by giving certain concessions or facilities. If in the Budget savings are encouraged, then more deposits will be attracted towards the banks and in turn they can lend more money to the agricultural sector and industrial sector, therefore, booming the economy. If the FDI limits are relaxed, then more FDI are brought in India through banking channels

GROWING ECONOMY / GDP Indian economy has registered a growth of more that 9 per cent for last three year and is expected to maintain robust growth rate as compare to other developed and developing countries. Banking Industry is directly related to the growth of the economy. The contributions of various sectors in the Indian GDP for 2007-2008 are as follows:

1. Agriculture: 17%2. Industry: 29%3. Service Sector: 54%

It is great news that today the service sector is contributing more than half of the Indian GDP. It takes India one step closer to the develop economies of the world. Earlier it was agriculture which mainly contributed to the Indian GDP. The Indian government is still looking up to improve the GDP of the country and so several steps have been taken to boost the economy. Policies of FDI, SEZs and NRI investment have been framed to give a push to the economy and hence the GDP.

LOW INTEREST RATES: Reserve Bank of India controls the Interest rate, which is based on several monetary policies. Recently RBI has reduced the interest rate which stimulates the growth rate of banking industry. As on September 11, 2009 Bank Rate was 6.00 per cent, the same as on the corresponding date of last year. Call money rates (borrowing & lending) were in the range of 1.50/3.47 per cent as compared with 5.25/11.00 per cent on the corresponding date of last year.

INFLATION RATES: Inflation represents a rise in general level of prices of goods and services over a period of time. It leads to erosion in the purchasing power of money. Resultantly, each unit of currency buys fewer goods and services Different fiscal and monetary policies have curbed the Inflation rate from the high of 12.63 per

cent to 3.92 per cent. To fight against the slowdown of the Economy, Government of India & Reserve Bank of India took many fiscal as well as monetary actions. Clubbed with fiscal & monetary actions, decreasing commodity prices, decreasing crude prices and lowering interest rate, we expect that Indian Economy could again register a robust growth rate in the year2009-10. Inflation stands at 3.92 per cent on 7th February 2009 against a high of 12.63per cent on 9th August 2008.

AGRICULTURE CREDIT: Agriculture has been the mainstay of our economy with 60% of our population deriving their sustenance from it. In the recent past, the sector has recorded a growth of about 4%per annum with substantial increase in plan allocations and capital formation in the sector. Agriculture credit flow was Rs 2, 87,000 crore in 2008-09. The target for agriculture credit flow for the year 2009-10 is being set at Rs.3, 25,000 crore. To achieve this, I propose to continue the interest subvention scheme for short term crop loans to farmers for loans up to Rs.3 lakhs per farmer at the interest rate of 7% per annum. For this year, the government shall pay an additional subvention of 1% as an incentive to those farmers who repay their short term crop loans on schedule. Thus, the interest rate for these farmers will come down to 6% per annum. For this, I am making an additional Budget provision of Rs 411 crore over Interim BE.

DEBT RELIEF FOR FARMERS: The one-time bank loan waiver of nearly Rs 71,000 crore to cover an estimated 40million farmer was one of the major highlights of the last Budget. Under the Agricultural Debt Waiver and Debt Relief Scheme (2008), farmers having more than two hectares of land were given time up to 30th June, 2009 to pay 75% of their over dues. Due to the late arrival of monsoon, I propose to extend this period by six months up to 31stDecember, 2009.

SOCIO CULTUREAL FACTORS

Socio culture factors also affect the business. They show in which people behave in country. Socio-cultural factors like taboos, customs, traditions, tastes, preferences, buying and consumption habit of people, their language, beliefs and values affect the business. Banking industry is also operates under this social environment and it is also affect by this factor.These factor are changing continuously people’s life style, their behavior, consumptionPattern etc. is changing and also creating opportunities and threat for banking industry. There is some socio-culture factors that affect banking in India have been analyzed below.

TRADITIONAL MAHAJAN PRATHA: Before the birth of the banks, people of India were used to borrow money local moneylenders, shahukars, shroffs. They were used to charge higher interest and also mortgage land and house. Farmers were exploited by these shahukars. But farmers need money. So, they did not have any choice other than going to shahukar and borrowing money from them in spite of exploitation by these people. But after emergence of banks attitude of people was changed. Traditional mahajan pratha still exist in India specially in rural areas. This affects the banking sector. Rural people afraid to go to bank to borrow money instead they prefer to borrow from shahukar with whom they have relationships from the time of their fore fathers. Banking infrastructure is also week in some interior areas of India. So, this is reason it still exist.

SHIFT TOWARDS NUCLEAR FAMILY: Attitude of people of India is changing. Now, younger generation wants to remain separate from their parents after they get married. Joint families are breaking up. There are many reasons behind that. But banking sector is positively affected by this trend. A family need home consumer durables like freeze, washing machine, television, bike, car, etc. so, they demand for these products and borrow from banks. Recently there is boost in housing finance and vehicle loans. As they do not have money they go for installments. So, banks satisfy nuclear families wants.

CHANGE IN LIFE STYLE: Life style of India is changing rapidly. They are demanding high class products. They have become more advanced. People want everything car, mobile, etc. what their forefather had dreamed for. Now teenagers also have mobile and vehicle. Even middle class people also want to have well furnished home, television, mobile, vehicle and this has opened opportunities for banking sector to tap this change. Everything is available so it has become easy to purchase anything if you do not have lump sum.

POPULATION: Increase in population is one of the important factors, which affect the private sector banks. Banks would open their branches after looking into the population demographics of the area. Percentage of deposit in any branches of banks depends upon the population demographic of that area. The population of India is about 102.90 is expected to reach about 119.70 cores in 2011. About 70% of population is below 35years of age. They are in the prime earning stage and this increase the earning of the banks. Total Deposits mobilized by the Private Sector Banks increased from Rs, 2,52,335 crore as on 31stMarch 2004 to Rs. 3,12,645 crore as on 31st March 2005. Deposits showed a subdued growth during 2004-05.Income distributions also affects the operations and overall business of private sector banks.

LITERACY RATE: Literacy rate in India is very low compared to developed countries. Illiterate people hesitate to transact with banks. So, this impacts negatively on banks. But there is positive side of this as well i.e. illiterate people trust more on banks to deposit their money; they do not have market information. Opportunities in stocks or mutual funds. So, they look bank as their sole and safe alternative.

TECHNOLOGICAL FACTORS

TECHNOLOGY IN BANKS: Technology plays a very important role in bank’s internal control mechanisms as well as services offered by them. It has in fact given new dimensions to the banks as well as services that they cater to and the banks are enthusiastically adopting new technological innovations for devising new products and services.

ATM: The latest developments in terms of technology in computer and telecommunication have encouraged the bankers to change the concept of branch banking to anywhere banking. The use of ATM and Internet banking has allowed “anytime, anywhere banking” facilities. Automatic voice recorders now answer simple queries, currency accounting machines makes the job easier and self-service counters are now encouraged. Credit card facility has encouraged an era of cashless society. Today MasterCard and Visa card are the two most popular cards used world over. The banks have now started issuing smartcards or debit cards to be used for making payments. These are also called as electronic purse. Some of the banks have also started home banking through telecommunication facilities and computer technology by using terminals installed at customers home and they can make the balance inquiry, get the statement of accounts, give instructions for fund transfers, etc. Through ECS we can receive the dividends and interest directly to our account avoiding the delay or chance of losing the post.

IT SERVICES & MOBILE BANKING: Today banks are also using SMS and Internet as major tool of promotions and giving great utility to its customers. For example SMS functions through simple text messages sent from your mobile. The messages are then recognized by the bank to provide you with the required information. All these technological changes have forced the banker’s to adopt customer-based approach instead of product-based approach Technology advancement has changed the face of traditional banking systems. Technology advancement has offer 24X7 banking even giving faster and secured service.

CORE BANKING SOLUTIONS: It is the buzzword today and every bank is trying to adopt it is the centralize banking platform through which a bank can control its entire operation the adoption of core banking solution will help bank to roll out new product and services.

1.2 Importance of NPA managementThe accumulation of huge non-performing assets in banks has assumed great importance. The depth of the problem of bad debts was first realized only in early 1990s. The magnitude of NPAs in banks and financial institutions is over Rs.1, 50,000 Crores. While gross NPA reflects the quality of the loans made by banks, net NPA shows the actual burden of banks. Now it is increasingly evident that the major defaulters are the big borrowers coming from the non-priority sector.

The banks and financial institutions have to take the initiative to reduce NPAs in a time bound strategic approach. Public sector banks figure prominently in the debate not only because they dominate the banking industries, but also since they have much larger NPAs compared with the private sector banks. This raises a concern in the industry and academia because it is generally felt that NPAs reduce the profitability of banks, weaken its financial health and erode its solvency. For the recovery of NPAs a broad framework has evolved for the management of NPAs under which several options are provided for debt recovery and restructuring.

Banks and FIs have the freedom to design and implement their own policies for recovery and write-off incorporating compromise and negotiated settlements.

The prudential norms for income recognition should be based on record of recovery and therefore SCBs/CCBs should not take unrealized income to profit and loss accounts. However in the case of certain states where the state co-op act provides for taking such unrealized interest to income head in the P & L A/C. it is necessary for those SCBs to make full provisioning for equivalent amount by charging to P & L A/C. In other words, the SCBs which are charging for interest to all overdue loans and if such interest remains unrealized the same may be taken to income account provided matching provision is fully made for the same by charging to P & L A/C. Accrued interest taken to income account in the previous year should also be provided in full in case the same becomes overdue.

Fee, commission and other income may be treated as the income only when the account is classified as standard; besides, a matching provision should be created to the extent such items were treated as income in the previous year but not realized in the subsequent year.

Fee and commission earned by banks as a result of renegotiation or scheduling of outstanding debts should be recognized on an accrual basis over the period of time covering the renegotiated of credit.

Even in the case of credit facilities backed by Government guarantee, overdue interest can be taken to P & L A/C. only in case of matching provision is made.

The bills purchased should be treated as overdue if the same remain unpaid. Interest may be charged to such bills and the same may be P & L A/C provided matching provision is made

1.3 ObjectivesThe basic idea behind undertaking the Grand Project on NPA was to:

To evaluate NPAs (Gross and Net) in different banks. To study the past trends of NPA To calculate the weighted of NPA in risk management in Banking To analyze financial performance of banks at different level of NPA To evaluate profitability positions of banks To evaluate NPA level in different economic situation. To Know the Concept of Non Performing Asset To Know the Impact of NPAs To Know the Reasons for NPAs To learn Preventive Measures To study of the concept of Non Performing Asset in Indian perspective. To study NPA standard of RBI To study the Reasons for & Impact of NPAs To evaluate the efficiency in managing Non Performing Asset of different

types of banks (Public, Private and Foreign banks) using NPA ratios & comparing NPA with profits.

To check the proportion of NPA of different types of banks in different categories.

1.4 Literature Review:

(Reddy, 2004). Reddy (2004) critically examined various issues pertaining to terms of credit of Indian banks. In this context, it was viewed that ‘the element of power has no bearing on the illegal activity. A default is not entirely an irrational decision. Rather a defaulter takes into account probabilistic assessment of various costs and benefits of his decision’.

Mohan (2003)1 conceptualised ‘lazy banking’ while critically reflecting on banks’ investment portfolio and lending policy.

Mohan (2004) emphasised on key lending terms of credit, such as maturity and interest-terms of loans to corporate sector. The Indian viewpoint alluding to the concepts of ‘credit culture’ owing to Reddy (2004) and ‘lazy banking’ owing to Mohan (2003a) has an international perspective since several studies in the banking literature agree that banks’ lending policy is a major driver of non-performing loans (McGoven, 1993, Christine 1995, Sergio, 1996, Bloem and Gorters, 2001).

Muniappan, (2002). The problem of NPAs is related to several internal and external factors confronting the borrowers .The internal factors are diversion of funds for expansion/diversification/modernisation, taking up new projects, helping/promoting associate concerns, time/cost overruns during the project implementation stage, business (product, marketing, etc.) failure, inefficient management, strained labour relations, inappropriate technology/technical problems, product obsolescence, etc., while external factors are recession, non-payment in other countries, inputs/power shortage, price escalation, accidents and natural calamities.

Rajaraman and Vasishtha (2002) in an empirical study provided an evidence of significant bivariate relationship between an operating inefficiency indicator and the problem loans of public sector banks.

Das and Ghosh (2003) empirically examined non-performing loans of India’s public sector banks in terms of various indicators such as asset size, credit growth and macroeconomic condition, and operating efficiency indicators.

Kaveri (2001) studied the non-performance assets of the various banks and suggested various strategies to reduce the extent of NPAs. In view of the steep rise in fresh NPA advances, credit should be strengthening. RBI should use some new policies/strategies to prevent NPAs.

Kumar (2006) studied the bank nationalization in India marked a paradigm shift in the focus of banking as it was intended to shift the focus from class banking to mass banking. Internationally also efforts are being made to study causes of financial inclusion and designing strategies to ensure financial inclusion of the poor disadvantaged. The banks also need to redesign their business strategies to incorporate specific plans to promote financial inclusion of low income group treating it both a business opportunity as well as a corporate social responsibilities.

1.5 Research Design

The research design that will be use is Descriptive Research.

Involves gathering data that describe events and then organizes, tabulates, depicts, and describes the data.

Uses description as a tool to organize data into patterns that emerge during analysis.

Often uses visual aids such as graphs and charts to aid the reader. Using of hypothesis testing.

1) Test of Correlation:

a) H0:There is no significant correlation between profits & NPAs of Public Sector Banks for last 10 yearsH1: There is correlation between profits & NPAs of Public Sector Banks for last 10years

b) H0:There is no significant correlation between profits & NPAs of Private Sector Banks for last 10 yearsH1: There is correlation between profits & NPAs of Private Sector Banks for last10 years

c) H0:There is no significant correlation between profits & NPAs of Foreign Banks for last 10 yearsH1: There is correlation between profits & NPAs of Foreign Banks for last 10 years

2) ANNOVA Test:

H0: There is no significant difference in NPAs of different types of banks among various sectors.H1: There is significant difference in NPAs of different types of banks among various sectors.

Scope of the Study:

To understand the concept of NPAs in Indian banking industry. To understand the causes & effects of NPA To analyze the past trends of NPA of public, private & foreign banks in different sector.

Source of data collection:

The data collected for the study was secondary data in Nature.

Sampling plan:

To prepare this Project I would like to take five banks from public sector as well as five banks from private sector.

Study Period: 10 years (1990-91 to 2010-11)

Limitations of this study can be:The limitations that can be arising in my study are:

1. It was critical for me to gather the financial data of the every bank of the Indian Banks so the better comparative analyses of the banks are not possible.

2. 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.

3. Since the Indian banking sector is so wide so it may not possible for me to cover all the banks of the Indian banking sector.

4. There are some data which are available for just 3 years while the same data for its counterparts were available for 10 years. So, exact comparison was not possible.

Beneficiary of the study:

The outcome analyzed from this study would be beneficial to various sections such as:

Banks: this study would definitely benefits the banks in a way that directs them as to which sector should be given priority for lending money.

Further Researchers: The major beneficiaries from the project would be the researchers themselves as this study would enhance their knowledge about the topic. They get an insight of the present scenario of this industry as this is the emerging industry in the financial sector of the economy.

Student: To get the understanding of NPA concept as a whole

Reason behind doing this research: I am interested in the banking sector and I want to make my future in the banking sector so decided to make my research study on the banking sector. I analyzed first the factors that are important for the banking sector and I came to know that 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, I chose the topic “COMPOSITION OF NPAs OF BANK SECTOR WISE”.

2. DIFFERENT TOOLS AND GUIDELINES

(USED TO REDUCE NPAs)

The guidelines also provide for Accounts with temporary deficiencies. The classification of an asset as NPA is required to be based on the record of recovery. Bank is not required to classify an advance account as NPA merely due to the existence of some deficiencies which are temporary in nature such as non-availability of adequate drawing power based on the latest available stock statement, balance outstanding exceeding the limit temporarily, non-submission of stock statements and non-renewal of the limits on the due date, etc. In the matter of classification of accounts with such deficiencies banks follow the following guidelines:

a. Banks is required to ensure that drawings in the working capital accounts are covered by the adequacy of current assets, since current assets are first appropriated in times of distress. Drawing power is required to be arrived at based on the stock statement which is current. However, considering the difficulties of large borrowers, stock statements relied upon by the banks for determining drawing power can be up to three months old. The outstanding in the account based on drawing power calculated from stock statements older than three months, would be deemed as irregular. A working capital borrowal account becomes NPA if such irregular drawings are permitted in the account for a continuous period of 90 days even though the unit may be working or the borrower's financial position is satisfactory.

b. Regular and ad hoc credit limits are required to be reviewed/ regularised not later than three months from the due date/date of ad hoc sanction. In case of constraints such as non-availability of financial statements and other data from the borrowers, the branch is required to furnish evidence to show that renewal/ review of credit limits is already on and would be completed soon. In any case, delay beyond six months is not considered desirable as a general discipline. Hence, an account where the regular/ ad hoc credit limits have not been reviewed/ renewed within 180 days from the due date/ date of ad hoc sanction will be treated as NPA.

As regards the upgradation of loan accounts classified as NPAs, the policy is simple. As soon as the arrears of interest and principal are paid by the borrower in the case of loan accounts classified as NPAs, the account should no longer be treated as non-performing and may be classified as standard accounts. With regard to upgradation of a restructured/ rescheduled account which is classified as NPA separate guidelines will be applicable.

The asset classification of borrowal accounts where a solitary or a few credits are recorded before the balance sheet date should be handled with care and without scope for subjectivity. Where the account indicates inherent weakness on the basis of the data available, the account should be deemed as a NPA. In other genuine cases, the

banks are required to furnish satisfactory evidence to the Statutory Auditors/Inspecting Officers about the manner of regularisation of the account to eliminate doubts on their performing status.

Another important point regarding asset classification is that it has to be borrower-wise and not facility-wise. It is difficult to envisage a situation when only one facility to a borrower/one investment in any of the securities issued by the borrower becomes a problem credit/investment and not others. Therefore, all the facilities granted by a bank to a borrower and investment in all the securities issued by the borrower are required to be treated as NPA and not the particular facility/investment or part thereof which has become irregular.

If the debits arising out of devolvement of letters of credit or invoked guarantees are parked in a separate account, the balance outstanding in that account also should be treated as a part of the borrower’s principal operating account for the purpose of application of prudential norms on income recognition, asset classification and provisioning.

Asset classification of accounts under consortium is required to be based on the record of recovery of the individual member banks and other aspects having a bearing on the recoverability of the advances. Where the remittances by the borrower under consortium lending arrangements are pooled with one bank and/or where the bank receiving remittances is not parting with the share of other member banks, the account will be treated as not serviced in the books of the other member banks and therefore, be treated as NPA.

The banks participating in the consortium are therefore, required to arrange to get their share of recovery transferred from the lead bank or get an express consent from the lead bank for the transfer of their share of recovery, to ensure proper asset classification in their respective books.

In respect of accounts where there are potential threats for recovery on account of erosion in the value of security or non-availability of security and existence of other factors such as frauds committed by borrowers it is not prudent that such accounts should go through various stages of asset classification. In cases of such serious credit impairment the asset are straightaway classified as doubtful or loss asset as appropriate.

2.1 TYPES OF NPA1. Gross NPA

2. Net NPA

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 nonstandard 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

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 - Provisions

2.2 Asset classificationRBI guidelines for asset classification:

1. Standard assets: An account (loan or investment) is classified as Performing Asset if it does not disclose any problems and carry more than normal risk attached to the business All loan facilities which are regular .

2. Sub-standard: Effective from year ended March 31, 2005, assets are classified substandard if they remain non-performing for less than or equal to 12 months. They have well defined credit weaknesses and are characterised by the distinct possibility that the bank will sustain some loss if the deficiencies are not rectified. The account, where the terms of loan agreement relating to payment of interest and repayment of principal have been negotiated or rescheduled after commencement of production, should be classified as sub-standard and retained as such for at least one year of satisfactory performance under the renegotiated terms.

3. Doubtful: Effective from year ended March 31, 2005, assets are classified doubtful if they remain non-performing for more than 12 months. They have all the weaknesses inherent in sub-standard assets with the added characteristic that collection or liquidation of the dues is highly improbable. As in the case of sub-standard asset, rescheduling does not entitle a bank to upgrade the quality of the account automatically.

4. Loss: These are assets where loss has been identified by the bank or internal / external auditors or RBI inspection, but the amount has not been written off, wholly or in part. Such assets are considered uncollectible and of so little value that their continuance as bankable assets is not warranted, even though there may be some salvage or recovery value.

Guidelines for asset classification:

Assets are to be classified generally on the basis of well-defined credit weaknesses and the extent of dependence on collaterals for realisation of dues. Net worth of borrower / guarantor should not be taken into account while determining whether an advance is NPA. Banks should bear in mind the following

RBI guidelines for asset classification:

(i) Identification of assets as NPA on on-going basis

Banks should identify assets as NPA on an on-going basis. They should evolve a system to eliminate the tendency to delay or postpone identification of NPA, particularly in respect of high-value accounts.They should internally resolve doubts regarding asset classification within one month of the date by which the account would have been classified as NPA as per prescribed norms.

(ii) Treatment of accounts as NPAa) Record of recovery

The classification of an asset as NPA has to be done on the record of recovery. Banks should not classify an account as non-performing due to the existence of ‘temporary deficiencies’ such as balance exceeding limit, non-availability of adequate drawing power, non-submission of stock statement or non-renewal of accounts on due date. If an account is regularised before the balance sheet date by repayment of overdue through genuine sources (not by sanction of additional facilities or transfer of funds between accounts), the account need not be treated as NPA. It should, however, be ensured that the account remains in order subsequently and a solitary credit made in the accounts near about the balance sheet date to extinguish the overdue interest or instalment of principal is not reckoned as the sole criterion for treating the account as a standard asset. In other genuine cases, banks must furnish to the Statutory Auditor / RBI Inspecting Officer satisfactory evidence of regularisation of the account. b) Classification as NPA for arrears in submission of stock statementsOutstanding in the account based on drawing power calculated from stock statements older than three months would be considered as irregular. A working capital account will be classified as NPA if such irregular drawings are allowed for more than 90 days.

(iii) Classification as NPA for non-review or non-renewal of limit An account, where regular/ad-hoc credit limits are not reviewed or not renewed, Within 90 days from the due date or date of ad-hoc sanction will be classified as NPA.

Provision on types of asset

Provision is allocating money every year to meet possible future loss.

2.3 Impact of NPA

1. Profitability: NPA means booking of money in terms of bad asset, which occurred due to wrong choice of client. Because of the money getting blocked the prodigality of bank decreases not only by the amount of NPA but NPA lead to opportunity cost also as that much of profit invested in some return earning project/assets. So NPA doesn’t affect current profit but also future stream of profit, which may lead to loss of some long-term beneficial opportunity. Another impact of reduction in profitability is low ROI (return on investment), which adversely affect current earning of bank.

2. Liquidity: Money is getting blocked, decreased profit lead to lack of enough cash at hand which lead to borrowing money for shortest period of time which lead to additional cost to the company. Difficulty in operating the functions of bank is another cause of NPA due to lack of money, and also face problem for Routine payments and dues.

3. Involvement of management: Time and efforts of management is another indirect cost which bank has to bear due to NPA. Time and efforts of management in handling and managing NPA would have diverted to some fruitful activities, which would have given good returns. Now day’s banks have special employees to deal and handle NPAs, which is additional cost to the bank.

4. Credit loss:

Bank is facing problems of NPA then it adversely affects the value of bank in terms of market credit. It will lose its goodwill and brand image and credit which have negative impact to the people who are putting their money in the banks.

TECHNIQUES USED FOR MANAGEMENT OF NPAs

3.1 EARLY SYMPTOMS

By which one can recognize a performing asset turning in to non-performing asset Four categories of early symptoms:-

1) Financial: Non-payment of the very first installment in case of term loan. Bouncing of cheque due to insufficient balance in the accounts. Irregularity in installment. Irregularity of operations in the accounts. Unpaid overdue bills. Declining Current Ratio. Payment which does not cover the interest and principal amount of

that installment. While monitoring the accounts it is found that partial amount is

diverted to sister concern or parent company.

2) Operational and Physical: If information is received that the borrower has either initiated the

process of winding up or are not doing the business. Overdue receivables. Stock statement not submitted on time. External non-controllable factor like natural calamities in the city where

borrower conduct his business. Frequent changes in plan. Nonpayment of wages.

3) Attitudinal Changes: Use for personal comfort, stocks and shares by borrower. Avoidance of contact with bank. Problem between partners.

4) Others: Changes in Government policies. Death of borrower. Competition in the market

3.2 REASONS FOR AN ACCOUNT BECOMING NPA

1. Internal factors

2. External factors

Internal factors:

1) Funds borrowed for a particular purpose but not use for the said purpose.

2) Project not completed in time.

3) Poor recovery of receivables.

4) Excess capacities created on non-economic costs.

5) In-ability of the corporate to raise capital through the issue of equity or other debt instrument from capital markets.

6) Business failures.

7) Diversion of funds for expansion\modernization\setting up new projects\ helping or promoting sister concerns.

8) Willful defaults, siphoning of funds, fraud, disputes, management disputes, mis-appropriation etc.

9) Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups, delaying settlement of payments\ subsidiaries by government bodies etc.,

External factors:

1) Sluggish legal system-Long legal tangles Changes that had taken place in labour laws Lack of sincere effort.

2) Scarcity of raw material, power and other resources.

3) Industrial recession.

4) Shortage of raw material, raw material\input price escalation, power shortage, industrial recession, excess capacity, natural calamities like floods, accidents.

5) Failures, nonpayment\ over dues in other countries, recession in other countries, externalization problems, adverse exchange rates etc.

6) Government policies like excise duty changes, Import duty changes etc., The RBI has summarized the finer factors contributing to higher level of NPAs in the Indian banking sector as:

Diversion of funds, which is for expansion, diversification, modernization, undertaking new projects and for helping associate concerns. This is also coupled with recessionary trends and failures to tap funds in capital and debt markets.

Business failures (such as product, marketing etc.), which are due to inefficient management system, strained labour relations, inappropriate technology/ technical problems, product obsolescence etc.

Recession, which is due to input/ power shortage, price variation, accidents, natural calamities etc. The externalization problems in other countries also lead to growth of NPAs in Indian banking sector.

Time/ cost overrun during project implementation stage.

Governmental policies such as changes in excise duties, pollution control orders etc.

Willful defaults, which are because of siphoning-off funds, fraud/ misappropriation, promoters/ directors disputes etc.

Deficiency on the part of banks, viz, delays in release of limits and payments/ subsidies by the Government of India.

PREVENTIVE MEASUREMENT FOR NPA:

1. Early Recognition of the Problem : Invariably, by the time banks start their efforts to get involved in a revival process, it’s too late to retrieve the situation- both in terms of rehabilitation of the project and recovery of bank’s dues. Identification of weakness in the very beginning that is: When the account starts showing first signs of weakness regardless of the fact that it may not have become NPA, is imperative. Assessment of the potential of revival may be done on the basis of a techno-economic viability study. Restructuring should be attempted where, after an objective assessment of the promoter’s intention, banks are convinced of a turnaround within a scheduled timeframe. In respect of totally unviable units as decided by the bank, it is better to facilitate winding up/ selling of the unit earlier, so as to recover whatever is possible through legal means before the security position becomes worse.

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Identifying borrowers with genuine intent from those who are non- serious with nocommitment or stake in revival is a challenge confronting bankers. Here the role of frontline officials at the branch level is paramount as they are the ones who haveintelligent inputs with regard to promoters‟ sincerity, and capability to achieveturnaround. Based on this objective assessment, banks should decide as quickly aspossible whether it would be worthwhile to commit additional finance.In this regard banks may consider having“Special Investigation”of all financialtransaction or business transaction, books of account in order to ascertain real factors thatcontributed to sickness of the borrower. Banks may have penal of technical experts withproven expertise and track record of preparing techno-economic study of the project of the borrowers.Borrowers having genuine problems due to temporary mismatch in fund flow or suddenrequirement of additional fund may be entertained at branch level, and for this purpose aspecial limit to such type of cases should be decided. This will obviate the need to routethe additional funding through the controlling offices in deserving cases, and help avertmany accounts slipping into NPA category.

TiimmeelliinneessssaannddAAddeeqquuaaccyyoof f rreessppoonnssee::

Longer the delay in response, grater the injury to the account and the asset. Time is acrucial element in any restructuring or rehabilitation activity. The response decided onthe basis of techno-

economic study and promoter‟s commitment, has to be ad

equate interms of extend of additional funding and relaxations etc. under the restructuringexercise. The package of assistance may be flexible and bank may look at the exit option.

FFooccuussoonnCCaasshhFFlloowwss::

While financing, at the time of restructuring the banks may not be guided by theconventional fund flow analysis only, which could yield a potentially misleading picture.Appraisal for fresh credit requirements may be done by analyzing funds flow inconjunction with the Cash Flow rather than only on the basis of Funds Flow.

MMaannaaggeemmeennttEEf f f f eeccttiivveenneessss::

The general perception among borrower is that it is lack of finance that leads to sicknessand NPAs. But this may not be the case all the time. Management effectiveness intackling adverse business conditions is a very important aspect that affects a borrowing

unit‟s fortunes. A bank may commit additional finance to an aling unit only after basic

viability of the enterprise also in the context of quality of management is examined andconfirmed. Where the default is due to deeper malady, viability study or investigativeaudit should be done

–

it will be useful to have consultant appointed as early as possibleto examine this aspect. A proper techno- economic viability study must thus become thebasis on which any future action can be considered.

MMuullttiipplleeFFiinnaanncciinngg::

During the exercise for assessment of viability and restructuring, a

Pragmatic andunified approach

by all the lending banks/ FIs as also sharing of all relevantinformation on the borrower would go a long way toward overall success of rehabilitation exercise, given the probability of success/failure.

In some default cases, where the unit is still working, the bank should make sure that

it captures the cash flows

(there is a tendency on part of the borrowers to switchbankers once they default, for fear of getting their cash flows forfeited), and ensurethat such cash flows are used for working capital purposes. Toward this end, thereshould be regular flow of information among consortium members. A bank, which isnot part of the consortium, may not be allowed to offer credit facilities to suchdefaulting clients. Current account facilities may also be denied at non-consortiumbanks to such clients and violation may attract penal action. The

Credit InformationBureau of India Ltd.(CIBIL)

may be very useful for meaningful informationexchange on defaulting borrowers once the setup becomes fully operational.

In a forum of lenders, the priority of each lender will be different. While one set of lenders may be willing to wait for a longer time to recover its dues, another lendermay have a much shorter timeframe in mind. So it is possible that the letter categoriesof lenders may be willing to exit, even a t a cost

–

by a discounted settlement of theexposure. Therefore, any plan for restructuring/rehabilitation may take this aspect intoaccount.

Corporate Debt Restructuring

mechanism has been institutionalized in 2001 toprovide a timely and transparent system for restructuring of the corporate debt of Rs.20 crore and above with the banks and FIs on a voluntary basis and outside the legalframework. Under this system, banks may greatly benefit in terms of restructuring of large standard accounts (potential NPAs) and viable sub-standard accounts withconsortium/multiple banking arrangements.

PROCEDURES FOR NPA IDENTIFICATION ANDRESOLUTION IN INDIA:

1.

Internal Checks and Control

Since high level of NPAs dampens the performance of the banks identification of potential problem accounts and their close monitoring assumes importance. Though mostbanks have Early Warning Systems (EWS) for identification of potential NPAs, theactual processes followed, however, differ from bank to bank. The EWS enable a bank toidentify the borrower accounts which show signs of credit deterioration and initiateremedial action. Many banks have evolved and adopted an elaborate EWS, which allowsthem to identify potential distress signals and plan their options beforehand, accordingly.The early warning signals, indicative of potential problems in the accounts, viz. persistentirregularity in accounts, delays in servicing of interest, frequent devolvement of L/Cs,units' financial problems, market related problems, etc. are captured by the system. Inaddition, some of these banks are reviewing their exposure to borrower accounts everyquarter based on published data which also serves as an important additional warningsystem. These early warning signals used by banks are generally independent of risk rating systems and asset classification norms prescribed by RBI.The major components/processes of a EWS followed by banks in India as brought out bya study conducted by Reserve Bank of India at the instance of the Board of FinancialSupervision are as follows:

Designating Relationship Manager/ Credit Officer for monitoring account/s

Preparation of `know your client' profile

Credit rating system

Identification of watch-list/special mention category accounts

Monitoring of early warning signals

Relationship Manager/Credit Officer

The Relationship Manager/Credit Officer is an official who is expected to have completeknowledge of borrower, his business, his future plans, etc. The Relationship Manager hasto keep in constant touch with the borrower and report all developments impacting the borrowable account. As a part of this contact he is also expected to conduct scrutiny andactivity inspections. In the credit monitoring process, the responsibility of monitoring acorporate account is vested with Relationship Manager/Credit Officer.

Know your client' profile (KYC)

Most banks in India have a system of preparing `know your client' (KYC) profile/creditreport. As a part of `KYC' system, visits are made on clients and their places of business/units. The frequency of such visits depends on the nature and needs of relationship.

Credit Rating System

The credit rating system is essentially one point indicator of an individual credit exposureand is used to identify measure and monitor the credit risk of individual proposal. At thewhole bank level, credit rating system enables tracking the health of banks entire creditportfolio. Most banks in India have put in place the system of internal credit rating. Whilemost of the banks have developed their own models, a few banks have adopted creditrating models designed by rating agencies. Credit rating models take into account varioustypes of risks viz. financial, industry and management, etc. associated with a borrowableunit. The exercise is generally done at the time of sanction of new borrowable accountand at the time of review renewal of existing credit facilities.

Watch-list/Special Mention Category

The grading of the bank's risk assets is an important internal control tool. It serves theneed of the Management to identify and monitor potential risks of a loan asset. Thepurpose of identification of potential NPAs is to ensure that appropriate preventive / corrective steps could be initiated by the bank to protect against the loan asset becomingnon-performing. Most of the banks have a system to put certain borrowable accountsunder watch list or special mention category if performing advances operating underadverse business or economic conditions are exhibiting certain distress signals. Theseaccounts generally exhibit weaknesses which are correctable but warrant banks' closerattention. The categorization of such accounts in watch list or special mention category provides early warning signals enabling Relationship Manager or Credit Officer toanticipate credit deterioration and take necessary preventive steps to avoid their slippageinto non performing advances. Early Warning Signals It is important in any early warningsystem, to be sensitive to signals of credit deterioration. A host of early warning signalsare used by different banks for identification of potential NPAs. Most banks in India havelaid down a series of operational, financial, transactional indicators that could serve toidentify emerging problems in credit exposures at an early stage. Further, it is revealedthat the indicators which may trigger early warning system depend not only on default inpayment of installment and interest but also other factors such as deterioration inoperating and financial performance of the borrower, weakening industry characteristics,regulatory changes, general economic conditions, etc. Early warning signals can beclassified into five broad categories viz.a)

Financialb)

Operationalc)

Bankingd)

Management ande)

External factors.

Financial

related warning signals generally emanate from the borrowers' balance sheet,income expenditure statement, statement of cash flows, statement of receivables etc.Following common warning signals are captured by some of the banks having relativelydeveloped EWS.

Financial warning signals

Persistent irregularity in the account

Default in repayment obligation

Devolvement of LC/invocation of guarantees

Deterioration in liquidity/working capital position

Substantial increase in long term debts in relation to equity

Declining sales

Operating losses/net losses

Rising sales and falling profits

Disproportionate increase in overheads relative to sales

Rising level of bad debt losses Operational warning signals

Low activity level in plant

Disorderly diversification/frequent changes in plan

Nonpayment of wages/power bills

Loss of critical customer/s

Frequent labor problems

Evidence of aged inventory/large level of inventory

Management related warning signals

Lack of co-operation from key personnel

Change in management, ownership, or key personnel

Desire to take undue risks

Family disputes

Poor financial controls

Fudging of financial statements

Diversion of funds

Banking related signals

Declining bank balances/declining operations in the account

Opening of account with other bank

Return of outward bills/dishonored cheques

Sales transactions not routed through the account

Frequent requests for loan

Frequent delays in submitting stock statements, financial data, etc.

Signals relating to external factors

Economic recession

Emergence of new competition

Emergence of new technology

2. Legal and regulatory regime:

Lokadalats

The institution of Lokadalat constituted under the Legal Services Authorities Act, 1987helps in resolving disputes between the parties by conciliation, mediation, compromise oramicable settlement. It is known for effecting mediation and counseling between theparties and to reduce burden on the court, especially for small loans. Cases involving suitclaims up to Rs. l million can be brought before the Lokadalat and every award of theLokadalat shall be deemed to be a decree of a Civil Court and no appeal can lie to anycourt against the award made by the Lokadalat. Several people of particular localitiesvarious social organizations are approaching Lokadalats which are generally presidedover by two or three senior persons including retired senior civil servants, defensepersonnel and judicial officers. They take up cases which are suitable for settlement of debt for certain consideration. Parties are heard and they explain their legal position.They are advised to reach to some settlement due to social pressure of senior bureaucratsor judicial officers or social workers. If the compromise is arrived at, the parties to thelitigation sign a statement in presence of Lokadalats which is expected to be filed in courtto obtain a consent decree. Normally, if such settlement contains a clause that if thecompromise is not adhered to by the parties, the suits pending in the court will proceed inaccordance with the law and parties will have a right to get the decree from the court. Ingeneral, it is observed that banks do not get the full advantage of the Lokadalats. It isdifficult to collect the concerned borrowers willing to go in for compromise on the daywhen the Lokadalat meets. In any case, we should continue our efforts to seek the help of the Lokadalat.

Enactment of SRFAESI Act

The "The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act" (SRFAESI) provides the formal legal basis and regulatoryframework for setting up Asset Reconstruction Companies (ARCs) in India. In additionto asset reconstruction and ARCs, the Act deals with the following largely aspects,

Securitization and Securitization Companies

Enforcement of Security Interest

Creation of a central registry in which all securitization and asset reconstructiontransactions as well as any creation of security interests has to be filed.The Reserve Bank of India (RBI), the designated regulatory authority for ARCS hasissued Directions, Guidance Notes, Application Form and Guidelines to Banks in April2003 for regulating functioning of the proposed ARCS and these Directions/ GuidanceNotes cover various aspects relating to registration, operations and funding of ARCS andresolution of NPAs by ARCS. The RBI has also issued guidelines to banks and financialinstitutions on issues relating to transfer of assets to ARCS, consideration for the sameand valuation of instruments issued by the ARCS. Additionally, the Central Governmenthas issued the security enforcement rules ("Enforcement Rules"), which lays down theprocedure to be followed by a secured creditor while enforcing its security interestpursuant to the Act. The Act permits the secured creditors (if 75% of the securedcreditors agree) to enforce their security interest in relation to the underlying securitywithout reference to the Court after giving a 60 day notice to the defaulting borrowerupon classification of the corresponding financial assistance as a non-performing asset.The Act permits the secured creditors to take any of the following measures:

Take over possession of the secured assets of the borrower including right totransfer by way of lease, assignment or sale;

Take over the management of the secured assets including the right to transfer byway of lease, assignment or sale;

Appoint any person as a manager of the secured asset (such person could be theARC if they do not accept any pecuniary liability); and

Recover receivables of the borrower in respect of any secured asset which hasbeen transferred. After taking over possession of the secured assets, the securedcreditors are required to obtain valuation of the assets. These secured assets maybe sold by using any of the following routes to obtain maximum value.

By obtaining quotations from persons dealing in such assets or otherwiseinterested in buying the assets;

By inviting tenders from the public;

Institution of CDR

Mechanism

The RBI has instituted the Corporate Debt Restructuring (CDR) mechanism forresolution of NPAs of viable entities facing financial difficulties. The CDR mechanisminstituted in India is broadly along the lines of similar systems in the UK, Thailand,Korea and Malaysia. The objective of the CDR mechanism has been to ensure timely andtransparent restructuring of corporate debt outside the purview of the Board for Industrialand Financial Reconstruction (BIFR), DRTs or other legal proceedings. The framework is intended to preserve viable corporate affected by certain internal/external factors andminimize losses to creditors/other stakeholders through an orderly and coordinatedrestructuring programme. RBI has issued revised guidelines in February 2003 withrespect to the CDR mechanism. Corporate borrowers with borrowings from the bankingsystem of Rs. 20crores and above under multiple banking arrangement are eligible underthe CDR mechanism. Accounts falling under standard, sub-standard or doubtfulcategories can be considered for restructuring. CDR is a nonstatutory mechanism basedon debtor-creditor agreement and inter-creditor agreement. Restructuring helps inaligning repayment obligations for bankers with the cash flow projections as reassessed atthe time of restructuring. Therefore it is critical to prepare a restructuring plan on thelines of the expected business plan along with projected cash flows.

Increased Powers to NCLTs and the Proposed Repeal of BIFR

In India, companies whose net worth has been wiped out on account of accumulatedlosses come under the purview of the Sick Industrial Companies Act (SICA) and need tobe referred to BIFR. Once a company is referred to the BIFR (and even if an enquiry ispending as to whether it should be admitted to BIFR), it is afforded protection againstrecovery proceedings from its creditors. BIFR is widely regarded as a stumbling block inrecovering value for NPAs. Promoters systematically take refuge in SICA - often there isa scramble to file a reference in BIFR so as to obtain protection from debt recoveryproceedings. The recent amendments to the Companies Act vest powers for revival andrehabilitation of companies with the National Company Law Tribunal (NCLT), in placeof BIFR, with modifications to address weaknesses experienced under the SICAprovisions. The NCLT would prepare a scheme for reconstruction of any sick companyand there is no bar on the lending institution of legal proceedings against such companywhilst the scheme is being prepared by the NCLT. Therefore, proceedings initiated byany creditor seeking to recover monies from a sick company would not be suspended bya reference to the NCLT and, therefore, the above provision of the Act may not havemuch relevance any longer and probably does not extend to the tribunal for this reason.However, there is a possibility of conflict between the activities

that may be undertakenby the ARC, e.g. change in management, and the role of the NCLT in restructuring sick companies. The Bill to repeal SICA is currently pending in Parliament and the process of staffing of NCLTs has been initiated