What is NPA in Banking Sector?

know is bank audit time every one talking about NPA What is npa

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Yes, it is called a non-performing asset or NPA. It is called such as while it is an "Asset", it does not bring substantial income to its owner or is just dormant. Call it a white elephant if you wish. Basically, it is having something that SHOULD work but does not. Take a look at the advertisement on the upper right hand of this page. It is supposed to make Non- Performing Assets work. Y!A know what you ask and puts the appropriate ADs on your question! Lol!

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CA pp jain In liberalizing economy banking and financial sector get high priority. Indian banking sector of having a serious problem due non performing. The financial reforms have helped largely to clean NPA was around Rs. 52,000 crores in the year 2004. The

earning capacity and profitability of the bank are highly affected due to this NPA is defined as an advance for which interest or repayment of principal or both remain out standing for a period of more than two quarters. The level of NPA act as an indicator showing the bankers credit risks and efficiency of allocation of resource. Reasons: Various studies have been conducted to analysis the reasons for NPA. What ever may be complete elimination of NPA is impossible. The reasons may be widely classified in two: (1) Over hang component (2) Incremental component Over hang component is due to the environment reasons, business cycle etc. Incremental component may be due to internal bank management, credit policy, terms of credit etc. Asset Classification : The RBI has issued guidelines to banks for classification of assets into four categories. 1. Standard assets: These are loans which do not have any problem are less risk. 2. Substandard assets: These are assets which come under the category of NPA for a period of less then 12 months. 3. Doubtful assets: These are NPA exceeding 12 months 4. Loss assets: These NPA which are identified as unreliable by internal inspector of bank or auditors or by RBI. The classification of assets of scheduled commercial bank. Table 1 (Amount Rs. crores)

Assets 2001 2002 2003 2004

Standard assets 494716 (88.6) 609972 (89.6) 709260 (91.2) 837130 (92.8) Sub standard assets 18206 (3.3) 21382 (3.1) 20078 (2.6) 21026 (2.3) Doubtful assets 37756 (6.8) 41201 (6.1) 39731 (5.1) 36247 (4.36) Loss assets 8001 (1.4) 8370 (1.2) 8971 (1.2) 7625 (0.8) Total NPA 63963 (11.4) 70953 (10.4) 68780 (8.8) 902027 (100)

Income recognition and provisioning Income from NPA is not recognized on accrued basic but is booked as income only when, it is actually received. RBI has also tightened red the provisions norms against asset classification. It ranges from 0.25% to 100% from standard asset to loss asset respectively. Gross and net NPA of different sector of bank Table 2 (end of March 31) (in %) category Gross NPA/ Gross Advance 2001 2002 2003 2004 Public sector bank 12.37 11.09 9.36 7.79 Private sector 8.37 9.64 8.07 5.84 Foreign bank 6.84 5.38 5.25 4.62

Table 3 (end of March 31) (in %) category Net NPA / Net Advance 2001

2002 2003 2004 Public sector bank 6.74 5.82 4.53 2.98 Private sector 2.27 2.49 2.32 1.32 Foreign bank 1.82 1.89 1.76 1.49

The table II and III shows that the percentage of gross NPA/ gross advance and net NPA/ net advance are in a decreasing trend. This shows the sign of efficiency in public and private sector bamks.but still if compared to foreign banks Indian private sector and public sector banks have a higher NPA. Management of NPA The table II&III shows that during initial sage the percentage of NPA was higher. This was due to show ineffective recovery of bank credit, lacuna in credit recovery system, inadequate legal provision etc. Various steps have been taken by the government to recover and reduce NPAs. Some of them are. 1. One time settlement / compromise scheme 2. Lok adalats 3. Debt Recovery Tribunals 4. Securitization and reconstruction of financial assets and enforcement of Security Interest Act 2002. 5. Corporate Reconstruction Companies 6. credit information on defaulters and role of credit information bureaus CONCLUSION The Indian banking sector is facing a serious problem of NPA. The extent of NPA is comparatively higher in public sectors banks. (Table II&III). To improve the efficiency and profitability, the NPA has to be scheduled. Various steps have been taken by government to reduce the NPA. It is highly impossible to have zero

percentage NPA. But at least Indian banks can try competing with foreign banks to maintain international standard.
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sset Reconstruction Companies

(ARCs) are organizational unit created to manage and recover illiquid NPAs acquired from banking system. ARCs act as bad banks by isolating NPAs from the balance sheets of banks/FIs and facilitate the later to concentrate on normal banking activities. A cross country experience suggests that ARCs have been successfully deployed to implement a comprehensive NPA management strategy in the aftermath of systemic banking crisis. In East Asian countries, Korea, Taiwan, Mexico, Thailand etc., the Governments have encouraged transfer of assets to ARCs through creation of supportive environment. In 1980s, United States used government sponsored ARC - Resolution Trust Corporation (RTC) to overcome thrift crisis. Governments may also provide special powers to ARCs that are not otherwise available to banking system. As on February 28, 2005, Reserve Bank of India has issued licence to 3 ARCs to be formed in India viz ASREC (I) Ltd. floated by Unit Trust of India, Asset Care Enterprise Ltd. floated by IFCI and Asset Reconstruction Company (I) Ltd. (Arcil) floated by ICICI, SBI, and IDBI.

Asset Reconstruction need for resolution driven approach

(a) ARC Models Globally, ARCs follow two approaches in relation to their functioning: Resolution Agency In this model, ARCs acquire and aggregate NPAs from various

lenders in order to quicken the process of corporate restructuring. ARCs act as debt aggregators and nodal resolution agencies. Rapid Disposal Agency The major objective is to acquire and rapidly liquidate the assets to investors after appropriate packaging. Focus of ARC is prompt sellTHE CHARTERED ACCOUNTANT 1522 MAY 2005

NPA Management
- Role of Asset Reconstruction Companies
A high level of NPAs in the banking system can severely affect the economy in many ways. Management and financial resources of the banking system are diverted to resolution of NPA causing an opportunity loss for productive use of resources. Large scale NPAs, when left unattended, cause continued economic and financial degradation. This results in a credit crunch and generally signals adverse investment climate. This explains why most countries in the grip of systemic financial and economic crisis have attempted system-wide clean up of NPAs as a part of restructuring of their banking system. The role of Asset Reconstruction Companies in managing these NPAs is discussed in this article.
The author is MD & CEO of Asset Reconstruction Company (India) Limited He can be reached at rajendra.kakkar@arcil.co.in

BANKING & FINANCE

Rajendra Kakker

In the Indian context, the issues arising from NPA stock are need to be addressed on a priority basis. The ARCs, therefore, needed to have focus on expeditious resolution of NPAs in order to address concerns of the banking system (either as a seller or as an investor) and unlock value in the NPAs.
down leaving the task of corporate restructuring to the investors (often foreign investors). (b) Critical success factors In the Indian context, the issues arising from NPA stock are need to be addressed on a priority basis. The ARCs, therefore, need to have focus on expeditious resolution of NPAs in order to address concerns of the banking system (either as a seller or as an investor) and unlock value in the NPAs. Further, ARCs acting primarily as nodal resolution agencies through effective debt aggregation are most likely to succeed in light of the banking landscape and lending practices. In light of the above, following factors will be critical to the success of ARCs in the Indian market: Ability to aggregate debt In order to implement a resolution strategy, ARCs should have demonstrable ability to acquire and aggregate debt from various lenders as also stature and competence to resolve inter-creditor issues effectively. Ability to attract funding - both domestic and foreign investors The other aspect of functioning of ARCs is their ability to fund the acquisition. NPA financing is as such a high-risk business. This is further compounded by the absence of market for NPAs and benchmarks in India. With expected high variance in success and failure ratio of assets, sustainability

of ARC will be based on its ability to attract/source funds at regular intervals. This would require high degree of structuring skills. This will be a key differentiating factor for the ARC in the Indian market. Credibility of the sponsors Credibility of sponsors assumes significant importance in order to effectively deal with moral hazard related issues, which are likely to arise particularly in this business where industry and its regulatory framework is evolving. Sponsors background, experience and strength in terms of their (i) track record - bankers, either as sellers or investors, will be sensitive in dealing with ARCs; (ii) ability to aggregate debt and arrange for funds as discussed above; (iii) ability to establish best industry practices transparency, disclosures and super-ordinate objective of value maximization at systemic level; (iv) ability to adopt and benchmark internal processes to global standards - (e.g. KAMCO Korea, Danaharta Malaysia); and (v) ability to attract best skill sets - resolution and structuring skills will be the nucleus around which ARC model will be built, act as a competitive advantage for one player vis--vis other players.

ARCs the Indian Scenario

Though India has not witnessed the level of systemic economic and financial crisis witnessed by Asian countries, the Government of India (GOI) proactively initiated measures in order to address the NPAs levels (both stock and flow) and quicken recovery from NPAs through enactment of the Securitisation and Reconstruction

of Financial Assets (FAs) and Enforcement of Security Interest (SARFAESI) Act, 2002., (the Act). The Act paves the way for setting up ARCs and their empowerment. Reserve Bank of India (RBI) has also issued detailed guidelines and prudential norms for functioning of ARCs. Unlike in other countries where ARCs are government sponsored or government has direct participation (including the funding support) in operations of ARCs, in India, the Government has minimal participation in the Non-Performing Loan (NPL) resolution process. The Indian ARC model envisages market forces to consolidate and attractively package lender interests, arrange funding for providing clean exit to seller banks and lend focused attention for NPL resolution. In line with the above objective, ARCs in India have been set up as non-government vehicles with the support from the banking system rather than debt aggregation and funding support under a government owned/supported model. Further, the Indian model envisages setting up of multiple ARCs and funding to be arranged by ARCs on their own. THE CHARTERED ACCOUNTANT 1523 MAY 2005

BANKING & FINANCE

Why SARFAESI Act?
The Debt Recovery Tribunal Act, 1993 enables the banks /Financial Institutions (banks/FIs) to file an application in the DRT towards recovery of amount from the lenders. There are several additional provisions in SARFAESI Act, which are as under: Registration and regulation of Securitization Companies / Reconstruction Companies (SC/RCs) by the RBI Facilitating securitisation of the FAs of banks/FIs with or without the benefit of underlying securities Facilitating easy transferability

of FAs by the banks/FIs. Issue of debentures or bonds or any other security in the nature of a debenture by SC/RCs towards acquisition of FAs by banks/FIs. Empowering SC/RCs to raise funds by issue of security receipts (SRs) to qualified institutional buyers Facilitating reconstruction of FAs acquired by exercising powers of enforcement of securities or change of management or other powers which are proposed to be conferred on the banks / FIs Empowering banks / FIs to take possession of securities given for financial assistance and sell or lease the same or take over management in the event of default.

Why ARCs in India?

(a) NPA Size merits a prompt response The reported gross level of NPAs in the Indian banking system is pegged at about Rs. 90,000 crore representing about 9% of gross advances. The net NPAs are at about 5% of total advances. The estimates of some agencies indicate the gross NPA level to be about Rs. 130,000 crore. A year-on-year analysis shows that while net NPAs have been decreasing, the gross NPAs have remain steady, indicating high level of provisioning but limited progress on recoveries by banking system. It also indicates the Provide and Hold approach by the banks. This slow progress is largely attributable to the following factors: NPA profile Large and mid-size NPAs, mainly in industrial sector, account for more then 50% of total NPAs of the system. Resolution of these assets would largely be through operation of industrial assets over an extended timeframe. This requires in- depth skills for operational and financial

restructuring either with the same promoters or change in hand. Banking landscape Indian banking landscape has traditionally been characterized by consortium / multiple lending with different classes of security. This results in significant inter-creditor issues inhibiting prompt implementation of most appropriate resolution strategy causing loss of value to all concerned. Most resolution approaches (under the SARFAESI Act, Corporate Debt Restructuring (CDR) mechanism etc.) in India call for debt aggregation of minimum 75% of secured debt. (b) ARCs bring effective intermediation in the NPA resolution process To resolve NPAs, debt aggregation capability and necessary skill sets for resolution are critical. ARCs with ability to aggregate debt of different classes are in a better position to address inter-creditor issues. The debt aggregation capability provides better leverage in implementing resolution strategy. Further, The Act has provided wide-ranging powers to ARCs for resolution of NPAs. ARCs have access to all possible routes available to banks/FIs for resolution as also access to additional empowerments viz. step-in rights and change in management, sale or lease of business [section 9(a) & 9(b) of the Act]. Thus, ARCs with focus and domain expertise in resolution and the statutory / regulatory empowerments for resolution are in a better position to implement timely resolution strategy thereby enhancing the value from recoveries. THE CHARTERED ACCOUNTANT 1524 MAY 2005

BANKING & FINANCE

Advantage to banks / FIs from sale of NPAs
Sale of the FAs to ARCs enables the banks to take off NPAs from

their books. Subsequent to the sale of NPAs no known liability devolves on the banks / FIs. The sale can provide for sharing of upside upon eventual realization by the ARC thereby continuing their association in the realization of NPAs. Sale of NPA would also release capital and reduce expenditure on NPA maintenance and release resources for core operations. Sellers have an opportunity to invest, as Qualified Institutional Buyers (QIBs), in Security Receipts (SRs) issued by ARCs for acquisition of NPAs thereby continuing to participate in the upside.

RBI guidelines to Banks /FIs on sale of FAs to SC/RCs

FAs which can be sold to SC/RCs - NPAs and - Standard Asset if 75% by value of the asset is classified as NPA in other banks / FIs Valuation of financial asset to be based on the estimated realizable value Banks/ FIs may receive cash/bonds/debentures as sale consideration or invest in SRs / Pass-through Certificates issued by SC/RCs Investment in SRs should be categorized as non-SLR investment Sale price < net book value - The shortfall should be debited to the profit and loss account of that year. Sale price > net book value - The excess provision will not be reversed but will be utilized to meet the shortfall/loss for transferring further FAs to ARCs. Investment in the SRs issued by SC/RCs in respect of the FAs sold by the Banks/FIs should be recognized at the lower of: - the redemption value of the SRs and

- the NBV of the financial asset. Agreement may be entered with SC/RCs for sharing of upside

AARCs and CDR mechanism

CDR and ARCs are two pronged strategy to address the NPA resolution. Co-existence of CDR and ARCs is a mutually beneficial association. CDR typically focuses on restructuring of viable businesses at early stages of distress while ARCs would focus on cases involving multi-pronged workouts involving sale of businesses and assets of the borrower company without any restriction on size of the debt. In a multiple ARCs model, it would be necessary to avoid fragmentation of debt, particularly in respect of large and medium sized NPAs. ARCs should focus on those cases where they are better positioned to aggregate debt. This will facilitate resolution process - a winwin approach for all.

Acquisition and Management of NPAs by ARCs

In accordance with the Act and RBI guidelines, ARCs can acquire the FAs of NPA companies on their own balance sheet or through the trust structure by floatation of schemes for raising resources through issuance of Security Receipts (SRs) from QIBs. The trust structure for acquisition and resolution of NPAs is preferred structure by the investors and in generally in line with the international practices. The detailed transaction structure as adopted by Arcil is depicted below: Arcil sets up a trust (The Trust) for the purpose of acquiring Non-Performing Assets on the books of the Bank (Assets). The Assets would be acquired at fair value based on assessment of realizable amount and time to resolution. The Trust raises resources through

formulation of schemes by issuing SRs to the eligible investors under THE CHARTERED ACCOUNTANT 1525 MAY 2005 CDR and ARCs are two pronged strategy to address the NPA resolution. Co-existence of CDR and ARCs is a mutually beneficial association. CDR typically focuses on restructuring of viable businesses at early stages of distress while ARCs would focus on cases involving multi-pronged workouts involving sale of businesses and assets of the borrower company without any restriction on size of the debt.

BANKING & FINANCE

SARFAESI (banks/ FIs etc.). Such monies received from QIBs are utilized towards payment of purchase consideration for the FAs to the sellers. The Trust is the legal owner of the Assets and the SR holders are beneficial owners of the same. Security Receipt represents undivided right, title and interest in the Trust Fund, including the Initial Trust Fund, the Contributions received by the Trustee, the Assets proposed to be acquired by the Trustee . The SRs are akin to Pass-through Certificates (PTCs). Arcil acts as a trustee and the asset manager of the Special Purpose Vehicle (SPV) trusts to fully leverage empowerments to ARCs under the SARFAESI for resolution of the Assets. The SR holders have no recourse against Arcil.

Key issues for effective functioning of ARCs

While the framework for effective functioning of ARCs has been laid down by the Act and RBI guidelines, a few enablers in operating and regulatory framework would go a long way in fulfilling the ARCs expected role. These are as follows: (a) Accelerating transfer of FAs to ARCs It may be noted that NPAs lose value over time. Therefore the banking system would stand to

gain if the NPAs are put on recovery path in the early stages either through ARCs or otherwise. The experience gained in acquisition of assets so far indicates a moderate response to transfer of assets. The book values of the banks / FIs are often higher than the price offers causing delays in decision to transfer or rejection of price offers (based on realistic estimates of recovery) requiring immediate write-offs. In such situations, the concerned bank/ FI tend to shy away from transfer. While there is a general desire amongst the banks / FIs to clean their books, the level and the milestones have to be defined by individual banks / FIs by recognising the value erosion in the NPA portfolio over and above the regulatory minimum. In this regard, RBIs recent guidelines on provisioning of doubtful assets and restriction on dividend would certainly provide the guidance to banks and FIs. (b) Participation of foreign investors (FIIs) in equity of ARCs and paper of ARCs For ARCs to effectively giving clean exit to seller banks/FIs in respect of NPAs attracting new investment is critical. FIls, which specialize in investing in distressed debt, would be the key source of such new funding as the domestic market does not have necessary risk appetite for such investment. However, the guidelines for the extent of FIIs investment in papers of ARCs (SRs) as well as route for their investment are not in place. Similarly, the equity investment in ARCs by FIIs is not yet permitted. (c) Rationalization of Stamp duty and registration charges on transfer of FAs to ARCs Stamp duty on assignment of debt with underlying security of movable/ immovable property is a State subject. Each State has different incidence of stamp duty on such transactions under their respective

Stamp Act ranging from 4% -14% of the transaction value. The transfer of FAs of NPAs to ARCs is held back in many States on account of high incidence of stamp duty on such transactions. While the matter has been taken up with respective States and many States such as Maharashtra, Gujarat, Rajasthan, Chattisgarh, Andhra Pradesh, Bihar and West Bengal have reduced stamp duty to a notional level recognising the nature of THE CHARTERED ACCOUNTANT 1526 MAY 2005

TRANSACTION STRUCTURE
Banks/FIs Scheme Borrower wise Borrower Sale of loan assets Reconstruction thru Restructuring/Asset sale/M&A Redemption of SRs Purchase Consideration Payment for Subscription to SRs Cash realization Investors Banks/FIs ARCs/ Trusts

BANKING & FINANCE

SRs transaction in case of transfer of assets to ARCs. The governments of other States would have to cap the stamp duty for transfer of assets. (d) Income-tax treatment of ARCs The trusts set up by ARCs for acquisition, management and resolution of NPAs in accordance with the Act are pass through in nature similar to mutual funds. It would be necessary to accord the same treatment for the ARC trusts as to Mutual Funds having regard to the

similarities in transaction structures by exempting income and TDS in the hands of the trust of ARCs. This would weed out inefficiency by reducing the transaction costs for investors. (e) Accounting Treatment of ARCs There are various transactions an ARC enters into. Many ARCs are also in the process of obtaining license from RBI. For standardization of accounting treatment and better comparisons of financial statements of various ARCs, accounting standard is required for ensuring transparency in accounts.

Conclusion
ARCs with statutory/ regulatory powers are likely to emerge as nodal resolution agencies co-existing with CDR mechanism. In the absence of direct funding support from the Government, ARCs are self-help mechanism of the banking system. The onus is with the banks/ FIs and ARCs to clean up the NPAs. The banks / FIs have to be proactive in making realistic provisions based on assessment of realizations from NPAs towards their dues. These practices will also enable banks/ FIs to move to internationally accepted norms. ARCs can add value by cutting short the time to resolution as well as maximizing the recoveries. This is possible by through debt aggregation and focused approach to resolution. The banks/ FIs that can not sell the assets immediately to ARCs due to possible balance sheet concerns should support the resolution efforts of ARCs. THE CHARTERED ACCOUNTANT 1527 MAY 2005

It may be noted that NPAs lose value over time. Therefore, the banking system would stand to gain if the NPAs are put on recovery path in the early stages either through ARCs or otherwise. The experience gained in

acquisition of assets so far indicates a moderate response to transfer of assets.

BANKING & FINANCE

Sub: Clarification regarding Inclusion of Insurance Financial Advisory Services under the Insurance Regulatory & Development Authority Act, 1999, including Insurance Brokerage in the definition of Management Consultancy & Other Services
The attention of the members is drawn to the Announcement published in the January 2005 issue of the Journal at page 935 as well as hosted in the website regarding inclusion of Insurance Financial Advisory Services under the Insurance Regulatory & Development Authority Act, 1999, including Insurance Brokerage in the definition of Management Consultancy and Other Services as appearing at pages 8-10 of Code of Ethics, January 2001 edition. In this regard, it may be clarified that as per the decision of the Council, a member is permitted to render Insurance Financial Advisory Services as prescribed under The Insurance Regulatory and Development Authority (Insurance Brokers) Regulations, 2002 only in Corporate form. Further, the members are required to comply with the conditions prescribed by the Insurance Regulatory & Development Authority and the conditions to be prescribed by The Institute of Chartered Accountants of India. It may also be clarified that the members are not permitted to do any work relating to insurance agency as prescribed under Insurance Regulatory and Development Authority (Licencing of Insurance Agents) Regulations, 2000 and Insurance Regulatory and Development Authority (Licencing of Corporate Agents) Regulations, 2002, either individually or in partnership/proprietorship form or in corporate form. The existing position regarding allowing members generally to hold life insurance agency licence for limited purpose of getting renewal commission, still hold good as provided in the Appendix (9) to the Chartered Accountants Regulations, 1988 (2002 edition).

NPA management biggest challenge for banks in 2009

Press Trust Of India / Mumbai December 30, 2008, 0:17 IST

After the global financial turmoil in 2008, Indian banks begin the new year with a lurking fear that their Non Performing Assets (NPA) would go up with their portfolios coming under severe stress. There is already a visible strain on consumer, credit card and vehicle loan portfolios and many banks have taken conscious decision to scale down their advances to risky sectors. Some banks have also revised their credit growth targets downwards as the year has come to a close. Click here to visit SME Buzz

The ongoing financial crisis has had its toll on export-related sectors like IT, textile and SMEs. This may indirectly impact banks asset quality. There is, therefore, a pressing need to ensure adequate risk-management mechanisms to overcome this challenge, State-owned Bank of Barodas (BoB) Chairman and Managing Director M D Mallya said. Indian banks witnessed a sharp jump in their gross NPAs for the first time in six years in FY08, compelling many of them to enhance their existing risk assessment tools. Gross NPAs of commercial banks in FY08 escalated by Rs 6,136 crore, according to figures released by the Reserve Bank. Though there was no need to be unduly alarmed, banks need to follow certain standard parameters to ensure the quality of their lending portfolios, Mallya said. Similar view was echoed by ICICI Banks CEOelect Chanda Kochhar who said the lender has taken a conscious decision to follow certain parameters to ensure asset quality. Despite pressures emanating from global financial markets, Indian banks witnessed a healthy 25-29 per cent average growth in credit disbursals, primarily in housing, auto and infrastructure loans. IndusInd Banks Head of Wholesale Banking Group, J Moses Harding supported this view saying that the present economic downturn has affected the repayment capacities of small firms, exerting pressure on the banks lending portfolios. There is a pressure on SMEs as many of them are unable to repay their advances in the current scenario. This situation is likely to last in the short term. Banks need to adjust their risk management mechanisms to face the situation, Harding said. Banks witnessed a huge credit demand from their corporate clients who found their foreign funding sources drying up in the aftermath of the global meltdown which originated with the subprime crisis in America in mid-2007. The growth in credit in the industry in 2008 was in the range of 25-29 per cent on account of working capital requirements of small-, mid- and large-size industries, and the bankers expect an average 25 per cent rise in their credit in 2009. While stateowned banks were quick to respond to the recent signals from policy-makers by reducing interest rates periodically, many Private Sector Banks (PSB) are yet to follow the suit, mainly owing to pressure on their margins.

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