Npa

NON-PERFORMING NON-PERFORMING ASSETSASSETS

What is NPAWhat is NPA…………

Non performing advancesNon performing advances or or non-non-performingperforming

AssetsAssets (or non-performing loans) are loans (or non-performing loans) are loans

that are not being repaid or serviced that are not being repaid or serviced through Interest payments on time.through Interest payments on time.

defdef: when interest or other dues to a bank : when interest or other dues to a bank remain unpaid for more than 90 days remain unpaid for more than 90 days the entire bank loan automatically turns the entire bank loan automatically turns a “a “Non-Performing AssetNon-Performing Asset””

Indian Economy and NPA’sIndian Economy and NPA’s The Indian Economy has been much The Indian Economy has been much

affected due to lack of infrastructure affected due to lack of infrastructure facilities, sticky legal system, cutting facilities, sticky legal system, cutting of exposures to emerging markets by of exposures to emerging markets by FII’s,etc.FII’s,etc.

Under such a situation it goes Under such a situation it goes without saying that banks are no without saying that banks are no exception and are bound to face the exception and are bound to face the heat of a global downturn.heat of a global downturn.

Banks and FII’s in India hold NPA’s Banks and FII’s in India hold NPA’s worth around Rs 1,10,000 crores.worth around Rs 1,10,000 crores.

Global Developments and NPA’sGlobal Developments and NPA’s

The core banking business is of The core banking business is of mobilizing the deposits and utilizing mobilizing the deposits and utilizing it for lending to industry.it for lending to industry.

Lending business is encouraged Lending business is encouraged which helps in productive purposes which helps in productive purposes which results in economic growth.which results in economic growth.

However lending also carries credit However lending also carries credit risk, which arises from the borrower’s risk, which arises from the borrower’s inability to repay it .inability to repay it .

How much risk can a bank How much risk can a bank afford to take?afford to take?

Recent happenings in the business Recent happenings in the business world-Enron, Worldcom, Xerox, global world-Enron, Worldcom, Xerox, global crossing do not give much confidence to crossing do not give much confidence to banks.banks.

The history of FII’s also reveals the fact The history of FII’s also reveals the fact that the biggest banking failures were that the biggest banking failures were due to credit risk.due to credit risk.

Due to this, banks are restricting their Due to this, banks are restricting their lending operations to secured avenues lending operations to secured avenues only with adequate collateral on which to only with adequate collateral on which to fall back upon in a situation of default.fall back upon in a situation of default.

Why NPA’s have become an issue Why NPA’s have become an issue for banks and FII’s in India?for banks and FII’s in India?

The origin of the problem of burgeoning The origin of the problem of burgeoning NPA’s lies in the quality of managing credit NPA’s lies in the quality of managing credit risk by the banks concerned.risk by the banks concerned.

What is needed is having adequate What is needed is having adequate preventive measures in place namely, fixing preventive measures in place namely, fixing pre-sanctioned appraisal responsibility & pre-sanctioned appraisal responsibility & having an effective post-disbursement having an effective post-disbursement supervision.supervision.

Banks concerned should continuously Banks concerned should continuously monitor loans to identify accounts that have monitor loans to identify accounts that have potential to become non-performing.potential to become non-performing.

Resolution of NPA’sResolution of NPA’s At present, local banks are saddled with At present, local banks are saddled with

the management of NPA’s for which the management of NPA’s for which they do not have management time for they do not have management time for proper resolution.proper resolution.

As a result, they are reluctant to make As a result, they are reluctant to make new loan to industrial or commercial new loan to industrial or commercial enterprises as NPA’s have strained their enterprises as NPA’s have strained their resources. resources.

The unavailability of new loans has The unavailability of new loans has therefore hindered economic growth therefore hindered economic growth and development.and development.

Contd…… Contd…… ADB intends to assist local banks resolve ADB intends to assist local banks resolve

their problems with NPA’s by facilitating the their problems with NPA’s by facilitating the financing of SPV’s and other mechanisms financing of SPV’s and other mechanisms designed to acquire and service such assets.designed to acquire and service such assets.

This will enable the local banking system to This will enable the local banking system to focus on its core operations and provide focus on its core operations and provide financing to productive sectors of economy.financing to productive sectors of economy.

In addition ADB will assist distressed In addition ADB will assist distressed companies in their restructuring & companies in their restructuring & rehabilitation efforts. rehabilitation efforts.

Indian Banking systems – some Indian Banking systems – some hard factshard facts

Gross NPA’s of the financial system is Gross NPA’s of the financial system is placed at Rs 1,35,000 crore, of which, over placed at Rs 1,35,000 crore, of which, over Rs 98,000 crore pertains to Scheduled Rs 98,000 crore pertains to Scheduled Commercial Banks (SCB’s) and FII’s.Commercial Banks (SCB’s) and FII’s.

Gross NPA’s showed increasing trend over Gross NPA’s showed increasing trend over the yrs and accretion to gross NPA’s by the yrs and accretion to gross NPA’s by SCB’s during last two fiscals were Rs SCB’s during last two fiscals were Rs 24,824 crore(2001-02) & Rs 21,862 24,824 crore(2001-02) & Rs 21,862 crore(2002-03).crore(2002-03).

Contd…….Contd……. This accretion is not considering the cases This accretion is not considering the cases

restructured through CDR mechanism during restructured through CDR mechanism during 2002-03 and thereafter (Rs 46,000 crore).2002-03 and thereafter (Rs 46,000 crore).

On account of low “Loan to GDP Ratio” (around On account of low “Loan to GDP Ratio” (around 60%) in India, the enormity of NPA’s in India in 60%) in India, the enormity of NPA’s in India in GDP term appears to be low in comparison GDP term appears to be low in comparison with china, korea, etc.with china, korea, etc.

43% of the capital base of the financial system 43% of the capital base of the financial system stands eroded on account of net NPA’s.stands eroded on account of net NPA’s.

RBI Guidelines on classification RBI Guidelines on classification of bank advancesof bank advances

According to RBI guidelines, bank advances According to RBI guidelines, bank advances are mainly classified into:are mainly classified into:

Standard assets: Standard assets: such an asset is not a such an asset is not a Non-Performing Asset.Non-Performing Asset.

Sub-standard assetsSub-standard assets: it is classified as : it is classified as NPA for a period not exceeding 18 months.NPA for a period not exceeding 18 months.

Doubtful assets:Doubtful assets: Asset that has remained Asset that has remained sub standard for a period of 12 months sub standard for a period of 12 months (w.e.f. March 31, 2005).(w.e.f. March 31, 2005).

Loss Assets: Loss Assets: here loss is identified by the here loss is identified by the banks concerned or by internal auditors or banks concerned or by internal auditors or by RBI inspectors.by RBI inspectors.

Financial statements in assessing Financial statements in assessing the risk of default for lendersthe risk of default for lenders

For banks and Financial Institutions, both For banks and Financial Institutions, both the balance sheet and income statement the balance sheet and income statement have a key role to play by providing have a key role to play by providing valuable information on a borrowers abilityvaluable information on a borrowers ability

The key accounting ratios generally used The key accounting ratios generally used for the purpose of ascertaining the for the purpose of ascertaining the creditworthiness of a business entity are creditworthiness of a business entity are that of debt-equity ratio & interest that of debt-equity ratio & interest coverage ratio.coverage ratio.

Measures to reduce NPA’sMeasures to reduce NPA’s

Provision of bad debts from net profit.Provision of bad debts from net profit. Implementation of Securitisation Act Implementation of Securitisation Act

2002.2002. Increasing the share of Retail business Increasing the share of Retail business

i.e., personal loans, vehicle loans, i.e., personal loans, vehicle loans, home loans, credit cards, etc.home loans, credit cards, etc.

Increasing the deposits.Increasing the deposits. Increase lending share to priority Increase lending share to priority

sector.sector.

High cost of funds due to NPAHigh cost of funds due to NPA

Quite often genuine borrowers face difficulties in Quite often genuine borrowers face difficulties in raising funds from banks due to mounting NPA’s.raising funds from banks due to mounting NPA’s.

With the enactment of the Securitiastion and With the enactment of the Securitiastion and Reconstruction of Financial Assets and Reconstruction of Financial Assets and enforcement of Security Interest Act, 2002, banks enforcement of Security Interest Act, 2002, banks can issue notices to pay up the dues can issue notices to pay up the dues

And the borrowers will have to clear the dues And the borrowers will have to clear the dues within 60 days.within 60 days.

If the defaulters don’t pay the dues, then the If the defaulters don’t pay the dues, then the banks can takeover the possession of assets & banks can takeover the possession of assets & also takeover the management of the company.also takeover the management of the company.

Credit Risk And NPACredit Risk And NPA

NPAs are a result of past NPAs are a result of past action whose effects are action whose effects are realized in the realized in the present present

Credit risk is a much Credit risk is a much more forward-looking more forward-looking approach and is mainly approach and is mainly concerned with managing concerned with managing the quality of credit the quality of credit portfolio before default portfolio before default takes place takes place

Credit RatingCredit Rating

Credit rating has been explained as forming an Credit rating has been explained as forming an opinion of the future ability, legal obligation and opinion of the future ability, legal obligation and willingness of a bond issuer or obligor to make willingness of a bond issuer or obligor to make full and timely payments on principal and interest full and timely payments on principal and interest due to the investors due to the investors

Definition by MoodyDefinition by Moody

Tangled By Huge NPAs……..WHYTangled By Huge NPAs……..WHY

Indian banks so far were Indian banks so far were encircled by the chains encircled by the chains of regulation and aegis of regulation and aegis of protection of protection

No formal policies, No formal policies, procedures, systems, procedures, systems, tools and techniques of tools and techniques of credit risk assessment credit risk assessment

At The Mercy Of Balance SheetAt The Mercy Of Balance Sheet

Operating marginOperating margin Current ratio Current ratio cash flowcash flow Fund flowFund flow

Perception and reality may differ Perception and reality may differ 180*180*

Accounting policies has Accounting policies has loopholesloopholes

Chartered Accountants Chartered Accountants make their balance sheet make their balance sheet look as they want it to look as they want it to look like look like

Past performance is no Past performance is no indicator of the future indicator of the future performance ideally performance ideally

Darling Of Bourses Takes A HitDarling Of Bourses Takes A Hit

Hasty commitments to expand rapidly by Hasty commitments to expand rapidly by rediff have brought it to red rediff have brought it to red

Its share price is ruling well below its issue Its share price is ruling well below its issue price price

So relying completely on the past ratios meant So relying completely on the past ratios meant no monitoring of the management decisions no monitoring of the management decisions and no control over their decisions and no control over their decisions

Collateral-A Defensive ApproachCollateral-A Defensive Approach

Collateral was another way to judge the credit Collateral was another way to judge the credit quality quality A client is good if she had attractive assets to A client is good if she had attractive assets to put as collateral and bad otherwise. put as collateral and bad otherwise. Poor decision making-accepted clients of poor Poor decision making-accepted clients of poor quality and rejected the clients of good quality quality and rejected the clients of good quality Collateral is hardly a security Collateral is hardly a security

Credit Risk TechniquesCredit Risk Techniques

QuantitativeQuantitative Ratio analysisRatio analysis Fund flowsFund flows Mathematical modelsMathematical models

QualitativeQualitative PoliciesPolicies ProceduresProcedures Concentration Concentration

Playing with PrecisionPlaying with Precision

Altman's Z Score predicts Altman's Z Score predicts whether or not a company is whether or not a company is likely to enter into likely to enter into bankruptcy within one or bankruptcy within one or two years two years the algorithm has been the algorithm has been consistently reported to consistently reported to have a 95 % accuracy of have a 95 % accuracy of prediction of bankruptcy prediction of bankruptcy Consideration-current Consideration-current assets, total assets, net assets, total assets, net sales, interest, total liability, sales, interest, total liability, current liabilities, market current liabilities, market value of equity, earnings value of equity, earnings before taxes and retained before taxes and retained earningsearnings

Play or LeavePlay or Leave

3.0 or more : Most 3.0 or more : Most likely safelikely safe

2.8 to 3.0 : Just safe2.8 to 3.0 : Just safe

1.8 to 2.7 : likely to 1.8 to 2.7 : likely to bankrupt in two yearsbankrupt in two years

Below 1.8 : Recovery Below 1.8 : Recovery least expectedleast expected

Getting The Combination RightGetting The Combination Right

Credit metrics Credit metrics works on the works on the statistical concepts statistical concepts like probability, like probability, means, and means, and standard deviation, standard deviation, correlation, and correlation, and concentrations concentrations

Credit Metrics-ApplicationCredit Metrics-Application Reduce the portfolio Reduce the portfolio

risk : reevaluate risk : reevaluate obligors having the obligors having the largest absolute size largest absolute size arguing that a single arguing that a single default among these default among these would have the would have the greatest impact greatest impact

reevaluate obligors reevaluate obligors having the highest having the highest percentage level of percentage level of risk arguing that these risk arguing that these are the most likely to are the most likely to contribute to portfolio contribute to portfolio losses losses

Balancing ActBalancing Act

Identifying the Identifying the correlations across the correlations across the portfolio so that the portfolio so that the potential concentration potential concentration may be reduced and the may be reduced and the portfolio is adequately portfolio is adequately diversified across the diversified across the uncorrelated uncorrelated constituents constituents

Concentration may lead Concentration may lead to an undue to an undue accumulation of risk at accumulation of risk at one point.one point.

ARCILARCIL

system-wide clean up system-wide clean up of NPAs result in of NPAs result in creation of Asset creation of Asset Reconstruction Reconstruction CompanyCompany

Governments may Governments may also provide special also provide special powers to ARCs that powers to ARCs that are not otherwise are not otherwise available to banking available to banking system system

ARCIL ObjectivesARCIL Objectives

Convert NPA into performing assetsConvert NPA into performing assets Act as nodal agency for NPA Act as nodal agency for NPA

resolutionresolution Create a vibrant market for NPA\Create a vibrant market for NPA\

restructured debtrestructured debt Re-energize the financial sector.Re-energize the financial sector.

Transaction StructureTransaction Structure

Transaction Structure- Transaction Structure- Stage-2Stage-2

ARCIL- International ARCIL- International ExamplesExamples

In 1980s, U.S. used government sponsored ARC - In 1980s, U.S. used government sponsored ARC - Resolution Trust Corporation (RTC) to overcome thrift Resolution Trust Corporation (RTC) to overcome thrift crisis. RTC acted as a “bad bank” and functioned as crisis. RTC acted as a “bad bank” and functioned as an effective sales mechanism for disposal of assets an effective sales mechanism for disposal of assets

In early 1990s Mexico and Sweden demonstrated In early 1990s Mexico and Sweden demonstrated successful use of ARC mechanism (Fobaproa and successful use of ARC mechanism (Fobaproa and Securum respectively) as a “bad bank” and to clean Securum respectively) as a “bad bank” and to clean and reprivatise/ recapitalise the banks and reprivatise/ recapitalise the banks

Korea used KAMCO as the nodal agency for acquiring Korea used KAMCO as the nodal agency for acquiring and disposing NPAs. KAMCO has used securitisation and disposing NPAs. KAMCO has used securitisation and joint venture route for investor participation in and joint venture route for investor participation in the assets the assets

Indian Financial System -2003-Indian Financial System -2003-04 04

Quantitative FactorsQuantitative Factors

Carrying Cost of NPAs 6.50% Carrying Cost of NPAs 6.50% Management Cost 0.75% Management Cost 0.75% Total Cost 7.25% Total Cost 7.25% Net NPAs of banks/FIs is Rs. 470 billions Net NPAs of banks/FIs is Rs. 470 billions Total holding Cost comes to Rs. 35 Total holding Cost comes to Rs. 35

billions p.a. for banks/FIs.billions p.a. for banks/FIs. Which is around 20% of the reported Net Which is around 20% of the reported Net

profit (i.e., including non-core income)profit (i.e., including non-core income)

Qualitative FactorsQualitative Factors

Banks fail to get “Interest spread” on the Banks fail to get “Interest spread” on the net realizable value of NPAs so long they net realizable value of NPAs so long they carry them in their books.carry them in their books.

Reduction of Risk Adjusted Capital Reduction of Risk Adjusted Capital Adequacy Ratio (RACAR). RBI deducts net Adequacy Ratio (RACAR). RBI deducts net NPA from capital and risk weighted assets NPA from capital and risk weighted assets to compute RACAR.to compute RACAR.

Carrying NPAs in books affects Rating and Carrying NPAs in books affects Rating and Capital mobilization.Capital mobilization.

MANAGING NPAMANAGING NPA

There are two issues, which, if tackled properly, would efficiently There are two issues, which, if tackled properly, would efficiently solve the problem of NPAs viz.solve the problem of NPAs viz.

(i) ‘STOCK’ ( accumulation of NPAs) problem and(i) ‘STOCK’ ( accumulation of NPAs) problem and (ii) ‘FLOW’ ( accretion ) problem.(ii) ‘FLOW’ ( accretion ) problem.

Several measures like Lok Adalat, DRTs( Debt Recovery Several measures like Lok Adalat, DRTs( Debt Recovery Tribunals),Strengthening of credit appraisal and monitoring Tribunals),Strengthening of credit appraisal and monitoring system have been initiated by the regulators to tackle the ‘flow’ system have been initiated by the regulators to tackle the ‘flow’ problem. problem.

Towards resolution of the ‘stock’ problem of NPAs GOI took proactive Towards resolution of the ‘stock’ problem of NPAs GOI took proactive steps and enacted the Securitasation & Reconstruction Act 2002 steps and enacted the Securitasation & Reconstruction Act 2002 in December 2002. in December 2002.

MANAGING NPA- ModelsMANAGING NPA- Models

Globally there have been two models:Globally there have been two models:

(i) A central disposition agency which takes (i) A central disposition agency which takes

bad loans from all financial institutions orbad loans from all financial institutions or

(ii) An entity specific to a particular bank or (ii) An entity specific to a particular bank or a group of banks e.g. Arcil.a group of banks e.g. Arcil.

MANAGING NPA- Resolution MANAGING NPA- Resolution StrategyStrategy

There are primarily two strategies There are primarily two strategies

(I) Loan Management Strategy(I) Loan Management Strategy

- Restructuring of loan on sustainable - Restructuring of loan on sustainable debt considerationsdebt considerations

- - Maximise overall recovery valueMaximise overall recovery value

- Fair treatment to all stakeholders- Fair treatment to all stakeholders

- One Time Settlement- One Time Settlement

MANAGING NPA- Resolution MANAGING NPA- Resolution StrategyStrategy

(II) Asset Management Strategy(II) Asset Management Strategy

- Disposition by strip sale- Disposition by strip sale

- Change in management- Change in management

- - Takeover of assetsTakeover of assets

- Legal route / Foreclosure- Legal route / Foreclosure

MANAGING NPA-Indian MANAGING NPA-Indian ApproachApproach

The Indian system envisages multiple The Indian system envisages multiple ARCs(Asset Reconstruction Company) as ARCs(Asset Reconstruction Company) as non government entities with equity non government entities with equity support of promoters.support of promoters.

The ARCs in India are not supported by The ARCs in India are not supported by through Govt. funding and are not through Govt. funding and are not structured like a Central disposition structured like a Central disposition agency. agency.

MANAGING NPA-Through ARCsMANAGING NPA-Through ARCs

ARCs are governed by the provisions of ARCs are governed by the provisions of

Securitisation Act 2002 and operates within the Securitisation Act 2002 and operates within the perview of RBI guidelines.perview of RBI guidelines.

The salient features of the Securitisation Act The salient features of the Securitisation Act in respect of ARCs are as follows:in respect of ARCs are as follows:

- - Unfettered right to the lenders acting in Unfettered right to the lenders acting in majority (> 75% by value) to enforce security majority (> 75% by value) to enforce security rights without judicial interventionrights without judicial intervention

Salient Features ….Salient Features ….

- - Establishment & empowerment of ARCs Establishment & empowerment of ARCs No single investor / sponsor to have No single investor / sponsor to have

majority control over ARCsmajority control over ARCs - Paves way for debt aggregation in ARCs by - Paves way for debt aggregation in ARCs by

enabling acquisition of assetsenabling acquisition of assets - Accords ARCs the rights of the lenders - Accords ARCs the rights of the lenders - Additional rights to ARCs – not available with - Additional rights to ARCs – not available with

lenders lenders Sale or lease of businesses by superceding Sale or lease of businesses by superceding

board powers board powers -Enables foreign investor participation-Enables foreign investor participation

MANAGING NPAMANAGING NPA

MEASURES FOR RECONSTRUCTION MEASURES FOR RECONSTRUCTION ( SECTION 9)( SECTION 9)

- Change in or takeover of management of - Change in or takeover of management of business of the borrowerbusiness of the borrower

- Sale or lease of part or whole business of - Sale or lease of part or whole business of the borrowerthe borrower

(Above two powers not available as of now, (Above two powers not available as of now, because RBI guidelines have not been because RBI guidelines have not been issued for the same)issued for the same)

MANAGING NPAMANAGING NPA

- Rescheduling of payment of debt- Rescheduling of payment of debt

- Enforcement of security interest in - Enforcement of security interest in accordance with the Actaccordance with the Act

- Settlement of dues payable by the - Settlement of dues payable by the borrowerborrower

- Taking possession of secured assets in - Taking possession of secured assets in accordance with the Actaccordance with the Act

Key Isuues before ARCsKey Isuues before ARCs

Valuation of NPAValuation of NPA

Debt AggregationDebt Aggregation

Legal & Regulatory Legal & Regulatory

Suggestions and ConclusionSuggestions and Conclusion

Siphoning off money or diversion of loans Siphoning off money or diversion of loans from banks should be erased from criminal from banks should be erased from criminal offence.offence.

Government funding/guarantee in some Government funding/guarantee in some form should be available for transfer of form should be available for transfer of assets to ARCs.assets to ARCs.

Banks should restrain itself from lending to Banks should restrain itself from lending to just about anything that is in fashion.just about anything that is in fashion.