A Chandramouliswaran: How to contain sticky loans

The RBI has taken some initiatives to tackle the problem, but there's a lot more to do

The non-performing assets (NPAs) of Indian banks may not be as much a cause for concern to the Reserve Bank of India (RBI) today as they were a few years ago.

The focused efforts of individual banks to bring down their NPAs under the RBI's regulatory guidance and surveillance have been assisted by favourable trends in the operational environment reflecting global economic developments.

There has been a sharp decline in the proportion of commercial banks' gross NPAs to gross advances from 12.7 per cent as on March 31, 2000, to 8.8 per cent as on 31 March 2003.

In absolute terms, however, gross NPAs rose by 13.7 per cent from Rs 60,408 crore to Rs 68,714 crore between March 31, 2000, and March 31, 2003, while net NPAs expanded by 8.9 per cent from Rs 30,073 crore to Rs 32,764 crore.

Public sector banks (PSBs) accounted for 78.7 per cent of the gross NPAs and 76.2 per cent of net NPAs at end-FY03, down from 87.8 per cent and 87.1 per cent, respectively, three years earlier.

Gross NPAs are important since they depress the overall yields on the banks' credit portfolio and constrain their ability to operate with lower margins and, in turn, their capacity to lower lending rates. Loan-loss provisioning and write-offs go to reduce the capital available for further asset creation.

Gross NPAs do not, however, disclose the entire picture of the overdues from borrowers. These exclude unpaid interest, including any penal interest, accrued on NPAs and, as a prudential measure, not recognised as income in the banks' financial statements.

The banks, however, have a contractual right to receive such interest, and a record of the interest is kept in a notional (suspense) account. It is included in the creditor-bank's claim against the borrower when legal proceedings are initiated for recovery of dues. When a settlement is reached with a borrower in respect of an NPA, the whole or a substantial part of the accrued and unrecognised interest may be forgiven.

A write-off of the NPA involves foregoing of the accrued interest. Hence, the magnitude of such interest dues assumes importance in assessing the likely losses a bank may suffer because of NPAs. Currently, this information is not required to be disclosed in banks' financial statements.

The tightened RBI norms for reckoning assets as non-performing and for non-recognition of income from such assets (by reducing the minimum period of debt-servicing default from 180 days to 90 days), effective from the quarter ended March 2004, would presumably have resulted in significant additions to NPAs during FY04.

Moreover, the further integration of the Indian economy with the global economy may subject the competitiveness and performance of Indian enterprises to increased pressures. Probable interest rate hikes in the near future would add to firms' operational costs and squeeze their profit margins. All these point to the need for constant vigilance aimed at containing fresh accretions to NPAs.

The RBI has taken commendable initiatives, starting from the early 1990s, to tackle the NPA problem by prescribing prudential requirements in line with international standards in relation to the recognition of income accrued on impaired loans and loan-loss provisioning. Some more measures by the RBI can improve the position further.

In the recent past, sluggish credit offtake coupled with growing liquidity in the banking system has led to intense competition among banks for new business, which in turn results in the dilution of their credit appraisal standards. Credit decisions based on a thorough appraisal of proposals without being influenced by extraneous considerations is a good first step to prevent potential non-performance of the facilities extended.

The RBI may need to impress upon banks the need to set up or strengthen their corporate research capabilities to furnish to credit-evaluation officials updated information on macro-economic trends and the current state; global competitiveness; near-term prospects of various industries; and the likely shifts in relevant government policies.

The RBI may also require banks to employ suitable software for analysing the balance-sheets of borrowers, which will help the analyses conform to a uniform format, leaving little scope for withholding unfavourable data.

Credit decisions, especially in the case of small- and medium-sized borrowers, are often influenced by the collateral offered "" generally immovable property. The best safeguard against credit risk is a critical evaluation of the borrower's prospective financial health and debt-servicing capacity, without undue reliance on the collateral.

A weak area in banks, especially PSBs, is the monitoring of borrowers subsequent to disbursal of credit facilities. Every PSB should be encouraged to introduce a system of effective monitoring of borrowers above specified floor levels for credit facilities.

The PSBs should be willing to spend a little more on credit monitoring if they wish to avoid fresh accretions of NPAs. In the case of consortium lending, it should be made clear that it is the primary responsibility of the consortium leader to keep a careful and continual watch on the borrower and keep co-lenders periodically with the outcome of the monitoring. Relying on this obligation of the lead bank, co-lenders themselves may not keep a close tab on the borrower.

In the case of banks, especially PSBs, there may be under-reporting of NPAs because of inadequate understanding and implementation by a large number of branches, of instructions relating to identification of NPAs and recognition of interest accrued on them.

The statutory central auditors may review advances at only a small percentage of branches and may accept data on NPAs reported by the remaining branches without an independent scrutiny of other advances at those branches.

A report of a National Task Force of the Confederation of Indian Industry (CII) on NPAs in the Indian financial system (December 1999) estimated that NPAs that were so left out of the final tally could be as high as 3 to 4 per cent of gross advances.

The RBI could, therefore, usefully examine the systems prevalent in the bank to ensure scrupulous compliance with the prudential requirements and the concrete results thereof achieved. In this examination, the commitment of the top management to present the true financial picture of the bank could also be looked into.

The RBI's advice to banks, in its recent credit policy statement, to introduce graded higher provisioning according to the age of NPAs included under "doubtful for more than three years' category" is welcome. Banks should take this measure as a hint not only to expedite recovery but also to write off these assets (unrecoverable portion) as early as possible.

The RBI should not hesitate to hold auditors responsible for any gross negligence or collusion with the bank's management in under-reporting NPAs and in the excess recognition of accrued income. It should strictly enforce its prudential guidelines on income recognition, loss provisioning and disclosure of the true financial health of banks.

It is also desirable that the RBI refrain from issuing guidelines on compromise settlements with borrowers in default. It has issued a plethora of circulars during the past decade, setting out the circumstances under which compromise proposals in certain cases could be entertained by banks and the extent of relief to be provided to the defaulting borrowers.

Such guidelines might have served a purpose before the RBI required each bank to formulate a credit recovery policy. Banks should be allowed operational freedom on compromise proposals based on merits within the framework of their recovery policy.

One would expect the RBI to periodically assess the effectiveness and impact of the recovery of debts under the Securitisation (SARFAESI) Act, corporate debt restructuring (CDR) and to promote statutory amendments and take necessary measures to assist these laws and mechanisms.

Up to June 2003, recoveries by resort to the SARFAESI Act totalled a meagre 4 per cent of the over-Rs 12,000 crore claimed by institutional lenders. Banks seem to have deferred wider recourse to the statutory powers pending the Supreme Court's decision on a landmark reference under the Act.

Opinions differed on whether the court's judgement, pronounced recently, would benefit the banks or the borrowers more. Some bankers were, however, apprehensive of the delays in recovery proceedings consequent to the judgement. The finance minister has taken care of this by promising in his Budget speech to promote suitable amendment to the relevant provisions of the Act.

The RBI should stick to the deadlines of September/ December 2004 for banks to obtain their borrowers' consent for sharing information on them with other banks and the Credit Information Bureau. Exchange of information and access to a centralised database on borrowers would serve the interests of the banks themselves.

It would be useful for the RBI to review many recommendations of the CII National Task Force for tackling NPAs. It's another matter that the CII has developed cold feet and does not seem to have pursued the recommendations following adverse references by critics to the alleged contribution of some of the large CII members, to the NPA problem.