NON-PERFORMING

ASSETS





What is NPA
Non performing advances or non-performing
Assets (or non-performing loans) are loans
that are not being repaid or serviced
through Interest payments on time.

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

Indian Economy and NPAs
The Indian Economy has been much
affected due to lack of infrastructure
facilities, sticky legal system, cutting of
exposures to emerging markets by
FIIs,etc.
Under such a situation it goes without
saying that banks are no exception and
are bound to face the heat of a global
downturn.
Banks and FIIs in India hold NPAs worth
around Rs 1,10,000 crores.
Global Developments and NPAs
The core banking business is of mobilizing
the deposits and utilizing it for lending to
industry.
Lending business is encouraged which
helps in productive purposes which results
in economic growth.
However lending also carries credit risk,
which arises from the borrowers inability
to repay it .
How much risk can a bank
afford to take?
Recent happenings in the business world-
Enron, Worldcom, Xerox, global crossing
do not give much confidence to banks.
The history of FIIs also reveals the fact
that the biggest banking failures were due
to credit risk.
Due to this, banks are restricting their
lending operations to secured avenues only
with adequate collateral on which to fall
back upon in a situation of default.
Why NPAs have become an issue
for banks and FIIs in India?
The origin of the problem of burgeoning NPAs lies
in the quality of managing credit risk by the banks
concerned.
What is needed is having adequate preventive
measures in place namely, fixing pre-sanctioned
appraisal responsibility & having an effective post-
disbursement supervision.
Banks concerned should continuously monitor
loans to identify accounts that have potential to
become non-performing.
Resolution of NPAs
At present, local banks are saddled with the
management of NPAs for which they do
not have management time for proper
resolution.
As a result, they are reluctant to make new
loan to industrial or commercial enterprises
as NPAs have strained their resources.
The unavailability of new loans has
therefore hindered economic growth and
development.
Contd
ADB intends to assist local banks resolve their
problems with NPAs by facilitating the financing
of SPVs and other mechanisms designed to
acquire and service such assets.

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

In addition ADB will assist distressed companies
in their restructuring & rehabilitation efforts.
Indian Banking systems some
hard facts

Gross NPAs of the financial system is placed
at Rs 1,35,000 crore, of which, over Rs
98,000 crore pertains to Scheduled
Commercial Banks (SCBs) and FIIs.

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

This accretion is not considering the cases
restructured through CDR mechanism during
2002-03 and thereafter (Rs 46,000 crore).

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

43% of the capital base of the financial system
stands eroded on account of net NPAs.

RBI Guidelines on classification
of bank advances
According to RBI guidelines, bank advances are
mainly classified into:
Standard assets: such an asset is not a Non-
Performing Asset.
Sub-standard assets: it is classified as NPA for
a period not exceeding 18 months.
Doubtful assets: Asset that has remained sub
standard for a period of 12 months (w.e.f. March
31, 2005).
Loss Assets: here loss is identified by the banks
concerned or by internal auditors or by RBI
inspectors.

Financial statements in assessing
the risk of default for lenders

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

The key accounting ratios generally used for the
purpose of ascertaining the creditworthiness of a
business entity are that of debt-equity ratio &
interest coverage ratio.
Measures to reduce NPAs
Provision of bad debts from net profit.
Implementation of Securitisation Act 2002.
Increasing the share of Retail business
i.e., personal loans, vehicle loans, home
loans, credit cards, etc.
Increasing the deposits.
Increase lending share to priority sector.
High cost of funds due to NPA
Quite often genuine borrowers face difficulties in raising
funds from banks due to mounting NPAs.

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

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

If the defaulters dont pay the dues, then the banks can
takeover the possession of assets & also takeover the
management of the company.
Credit Risk And NPA

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


Credit risk is a much
more forward-looking
approach and is mainly
concerned with managing
the quality of credit
portfolio before default
takes place
Credit Rating
Credit rating has been explained as forming an
opinion of the future ability, legal obligation and
willingness of a bond issuer or obligor to make
full and timely payments on principal and
interest due to the investors
Definition by Moody
Tangled By Huge NPAs..WHY
Indian banks so far were
encircled by the chains
of regulation and aegis
of protection
No formal policies,
procedures, systems,
tools and techniques of
credit risk assessment
At The Mercy Of Balance Sheet


Operating margin
Current ratio
cash flow
Fund flow
Perception and reality may differ
180*

Accounting policies has
loopholes
Chartered Accountants
make their balance sheet
look as they want it to
look like
Past performance is no
indicator of the future
performance ideally
Darling Of Bourses Takes A Hit
Hasty commitments to expand rapidly by
rediff have brought it to red
Its share price is ruling well below its issue
price
So relying completely on the past ratios meant
no monitoring of the management decisions
and no control over their decisions
Collateral-A Defensive Approach
Collateral was another way to judge the credit
quality
A client is good if she had attractive assets to
put as collateral and bad otherwise.
Poor decision making-accepted clients of poor
quality and rejected the clients of good quality
Collateral is hardly a security
Credit Risk Techniques

Quantitative
Ratio analysis
Fund flows
Mathematical models
Qualitative
Policies
Procedures
Concentration
Playing with Precision
Altman's Z Score predicts
whether or not a company
is likely to enter into
bankruptcy within one or
two years
the algorithm has been
consistently reported to
have a 95 % accuracy of
prediction of bankruptcy
Consideration-current
assets, total assets, net
sales, interest, total liability,
current liabilities, market
value of equity, earnings
before taxes and retained
earnings
Play or Leave

3.0 or more : Most
likely safe
2.8 to 3.0 : Just safe
1.8 to 2.7 : likely to
bankrupt in two years
Below 1.8 : Recovery
least expected
Getting The Combination Right

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

Credit Metrics-Application
Reduce the portfolio risk :
reevaluate obligors
having the largest
absolute size arguing that
a single default among
these would have the
greatest impact
reevaluate obligors
having the highest
percentage level of risk
arguing that these are
the most likely to
contribute to portfolio
losses
Balancing Act
Identifying the
correlations across the
portfolio so that the
potential concentration
may be reduced and the
portfolio is adequately
diversified across the
uncorrelated constituents
Concentration may lead
to an undue accumulation
of risk at one point.
ARCIL
system-wide clean up of
NPAs result in creation of
Asset Reconstruction
Company
Governments may also
provide special powers to
ARCs that are not
otherwise available to
banking system
ARCIL Objectives
Convert NPA into performing assets
Act as nodal agency for NPA resolution
Create a vibrant market for
NPA\restructured debt
Re-energize the financial sector.
Transaction Structure
Transaction Structure- Stage-2
ARCIL- International Examples
In 1980s, U.S. used government sponsored ARC -
Resolution Trust Corporation (RTC) to overcome thrift
crisis. RTC acted as a bad bank and functioned as an
effective sales mechanism for disposal of assets
In early 1990s Mexico and Sweden demonstrated
successful use of ARC mechanism (Fobaproa and
Securum respectively) as a bad bank and to clean and
reprivatise/ recapitalise the banks
Korea used KAMCO as the nodal agency for acquiring
and disposing NPAs. KAMCO has used securitisation and
joint venture route for investor participation in the assets
Indian Financial System -2003-04
Quantitative Factors

Carrying Cost of NPAs 6.50%
Management Cost 0.75%
Total Cost 7.25%
Net NPAs of banks/FIs is Rs. 470 billions
Total holding Cost comes to Rs. 35 billions
p.a. for banks/FIs.
Which is around 20% of the reported Net
profit (i.e., including non-core income)


Qualitative Factors
Banks fail to get Interest spread on the net
realizable value of NPAs so long they carry them
in their books.
Reduction of Risk Adjusted Capital Adequacy
Ratio (RACAR). RBI deducts net NPA from
capital and risk weighted assets to compute
RACAR.
Carrying NPAs in books affects Rating and
Capital mobilization.
MANAGING NPA
There are two issues, which, if tackled properly, would efficiently
solve the problem of NPAs viz.

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

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

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

MANAGING NPA- Models
Globally there have been two models:
(i) A central disposition agency which takes
bad loans from all financial institutions or
(ii) An entity specific to a particular bank or
a group of banks e.g. Arcil.
MANAGING NPA- Resolution
Strategy
There are primarily two strategies
(I) Loan Management Strategy
- Restructuring of loan on sustainable
debt considerations
- Maximise overall recovery value
- Fair treatment to all stakeholders
- One Time Settlement
MANAGING NPA- Resolution
Strategy
(II) Asset Management Strategy
- Disposition by strip sale
- Change in management
- Takeover of assets
- Legal route / Foreclosure
MANAGING NPA-Indian
Approach
The Indian system envisages multiple
ARCs(Asset Reconstruction Company) as
non government entities with equity
support of promoters.
The ARCs in India are not supported by
through Govt. funding and are not
structured like a Central disposition
agency.
MANAGING NPA-Through ARCs
ARCs are governed by the provisions of
Securitisation Act 2002 and operates within the
perview of RBI guidelines.
The salient features of the Securitisation Act
in respect of ARCs are as follows:
- Unfettered right to the lenders acting in
majority (> 75% by value) to enforce security
rights without judicial intervention
Salient Features .
- Establishment & empowerment of ARCs
No single investor / sponsor to have
majority control over ARCs
- Paves way for debt aggregation in ARCs by
enabling acquisition of assets
- Accords ARCs the rights of the lenders
- Additional rights to ARCs not available with
lenders
Sale or lease of businesses by superceding
board powers
-Enables foreign investor participation
MANAGING NPA
MEASURES FOR RECONSTRUCTION (
SECTION 9)
- Change in or takeover of management of
business of the borrower
- Sale or lease of part or whole business of
the borrower
(Above two powers not available as of now,
because RBI guidelines have not been
issued for the same)
MANAGING NPA
- Rescheduling of payment of debt
- Enforcement of security interest in
accordance with the Act
- Settlement of dues payable by the
borrower
- Taking possession of secured assets in
accordance with the Act
Key Isuues before ARCs
Valuation of NPA
Debt Aggregation
Legal & Regulatory
Suggestions and Conclusion
Siphoning off money or diversion of loans
from banks should be erased from criminal
offence.
Government funding/guarantee in some
form should be available for transfer of
assets to ARCs.
Banks should restrain itself from lending to
just about anything that is in fashion.