Credit Appraisal & Monitoring

Credit Appraisal & Monitoring
Session VII

Monitoring of Advance Accounts
And
Management of NPAs

by
Dinesh G. Mahabal

Agenda
1. Stages in Credit Deployment
2. Stages the Monitoring Process
3. Concepts, Causes & Consequences of Non
Performing Assets
Monday, September 22, 2014 Dinesh Mahabal MBA Banking 2
Background
Advance considered after through
appraisal it is expected that these
assets contribute to the income of the
bank seamlessly and continuously
As long as these assets are contributing
to the income as above, they are said to
be performing assets. If they stop
contributing the income they are
termed as Non-Performing.

STAGES IN CREDIT DEPLOYMENTFlow of Credit
Proposals.docx :
Some stages can be distinguished in credit
deployment.
Pre- sanction appraisal
Sanction: Based on DLP (Discretionary Lending
Powers) and Stipulation of Terms & conditions so as
to protect the Interest of the Institution
Process of Documentation
Disbursal and monitoring the end use of funds
Post sanction scrutiny (PSS):
Done by authority higher than the
sanctioning authority
Post sanction inspection and monitoring
Timely review (at least once in a year)
Noting of signs of problems in the
account and sorting them out

Management of NPAs
FOLLOW-UP :
QIS system
It is very essential that not only fresh advances
are granted judiciously, but the existing
advances already sanctioned / disbursed are
also followed up /reviewed at regular intervals.
Looking for indications of incipient sickness
(internal & external) and taking steps for
averting them, nursing and rehabilitation of sick
but viable units and recovery process

CONCEPT, CAUSES & CONSEQUENCES OF
NON-PERFORMING ASSETS
Concept
Every asset of the bank is acquired /created for a
specific purpose and each asset is designated to
perform a specified function
The assets of the bank can be broadly classified
into following categories:
Cash & balances with RBI & other banks.
Advances
Investments
Fixed Assets.
Other Assets.

Concept
The composition of each asset is determined by
the various policies of the bank viz. Business
Policy, Loan Policy, Investment Policy, Locational
CD Ratio etc. Besides, it is also governed by the
guidelines of RBI on CRR, SLR, depreciation on
investments, Risk Weightage etc.
The profitability of the bank is determined by
the income generated from the optimum use of
these assets after paying the cost of the funds
borrowed for acquiring these assets &
administrative costs.

Background
Background:
Before introduction of the Prudential Norms by
RBI in 1992, banks were treating the asset as
Performing or Non-Performing based on their
perception of the overall situation including the
integrity of the borrower, value of securities,
worth of the guarantors etc
Only when the situation becomes so bad that the
recovery of the principal itself is in doubt, leave
alone the interest, the banks were considering the
account as bad & doubtful and providing for
possible losses due to non-recovery
Such classifications were highly subjective and
differed from branch to branch

Background
In line with the international practices and as per
the recommendations made by the Committee on
the Financial System (Chairman Shri M.
Narasimham), the Reserve Bank of India has
introduced, in a phased manner, prudential norms
for income recognition, asset classification and
provisioning for the advances portfolio of the
banks
This is with a view to move towards greater
consistency and transparency in the published
accounts
IRACJuly14.pdf

Background
As per the RBIs directives; the policy of income
recognition should be objective and based on
record of recovery rather than on any subjective
considerations
Likewise, the classification of assets of banks has
to be done on the basis of objective criteria which
would ensure a uniform and consistent application
of the norms
Also, the provisioning should be made on the basis
of the classification of assets based on the period
for which the asset has remained nonperforming
and the availability of security and the realisable
value thereof

Background
Any Institution particularly a financial Institution
like Banks are required to ensure that while
granting loans and advances, realistic repayment
schedules may be fixed on the basis of cash flows
with borrowers. This would go a long way to
facilitate prompt repayment by the borrowers and
thus improve the record of recovery in advances
With the introduction of prudential norms, the
Health Code-based system for classification of
advances has ceased to be a subject of
supervisory interest. As such, all related reporting
requirements, etc. under the Health Code system
also cease to be a supervisory requirement

NPA defined
NPA defined
An asset, including a leased asset, becomes non
performing when it ceases to generate income
for the bank. Banks should, classify an account as
NPA only if the interest charged during any
quarter is not serviced fully within 90 days from
the end of the quarter
A non performing asset (NPA) is a loan or an
advance where;
FB: Interest and / or installment of principal
remain overdue for a period of more than 90
days in respect of a term loan, the account
remains out of order (Please see overleaf)
respect of an Overdraft / Cash Credit (OD/CC)
NPA defined
NFB: The bill remains overdue for a period of more than
90 days in the case of bills purchased and discounted
Agricultural: The installment of principal or interest
thereon remains overdue for two crop seasons for short
duration crops, the installment of principal or interest
thereon remains overdue for one crop season for long
duration crops.
Long duration crops would be crops with crop season
longer than one year and crops, which are not long
duration crops, would be treated as short duration
crops. The crop season for each crop, which means the
period up to harvesting of the crops raised, would be as
determined by the State Level Bankers Committee in each
State

NPA defined
Securitisatuion: The amount of liquidity facility
remains outstanding for more than 90 days, in
respect of a securitisation transaction undertaken in
terms of guidelines from RBI on securitisation dated
February 1, 2006.
Derivatives: In respect of derivative transactions,
the overdue receivables representing positive mark-
to-market value of a derivative contract, if these
remain unpaid for a period of 90 days from the
specified due date for payment.

NPA defined
--- conted.
Non Review/ Renew: 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.
Out of order : An account should be treated as 'out
of order' if the outstanding balance remains
continuously in excess of the sanctioned limit/drawing
power. In cases where the outstanding balance in the
principal operating account is less than the sanctioned
limit/drawing power, but there are no credits
continuously for 90 days as on the date of Balance
Sheet or credits are not enough to cover the interest
debited during the same period, these accounts should
be treated as 'out of order
Overdue: Any amount due to the bank under any
credit facility is overdue if it is not paid on the due
date fixed by the bank

Accounting For NPA
Interest Application
On an account turning NPA, banks should reverse the interest already
charged and not collected by debiting Profit and Loss account, and stop
further application of interest.
However, banks may continue to record such accrued interest in a
Memorandum account in their books. For the purpose of computing
Gross Advances, interest recorded in the Memorandum account should
not be taken into account.
Appropriation of recovery in NPAs
Interest realised on NPAs may be taken to income account provided the
credits in the accounts towards interest are not out of fresh/
additional credit facilities sanctioned to the borrower concerned
In the absence of a clear agreement between the bank and the
borrower for the purpose of appropriation of recoveries in NPAs (i.e.
towards principal or interest due), banks should adopt an accounting
principle and exercise the right of appropriation of recoveries in a
uniform and consistent manner.
Causes
The reasons for such account becoming NPA could
be any of the following internal or external
cause/s:
Sickness of the unit.
Destruction / Loss of the Asset Financed.
Willful default of the borrower.
Death of the borrower or other natural calamity
Whatever might be the reason as above, the fact
that the asset is not generating income and / or
principal remains overdue will make it a Non-
Performing Asset, notwithstanding the integrity
of the borrower, value of collaterals, assurance of
borrower to repay, security available etc.
ASSET CLASSIFICATION
Categories of NPAs
Banks are required to classify
nonperforming assets further into the
following three categories based on the
period for which the asset has remained
nonperforming and the realisability of
the dues:
i. Substandard Assets
ii. Doubtful Assets
iii. Loss Assets

Substandard Assets
A substandard asset would be one, which has
remained NPA for a period less than or equal
to 12 months. In such cases, the current net
worth of the borrower/ guarantor or the
current market value of the security charged is
not enough to ensure recovery of the dues to
the banks in full
In other words, such an asset will have well
defined credit weaknesses that jeopardise the
liquidation of the debt and are characterised by
the distinct possibility that the banks will
sustain some loss, if deficiencies are not
corrected

Doubtful Assets
An asset would be classified as doubtful if
it has remained in the substandard
category for a period of 12 months
A loan classified as doubtful has all the
weaknesses inherent in assets that were
classified as substandard, with the added
characteristic that the weaknesses make
collection or liquidation in full, on the
basis of currently known facts, conditions
and values highly questionable and
improbable

Loss Assets
A loss asset is one where loss has been
identified by the bank or internal or
external auditors or the RBI inspection
but the amount has not been written off
wholly
In other words, such an asset is
considered uncollectible and of such little
value that its continuance as a bankable
asset is not warranted although there may
be some salvage or recovery value.

Impact of NPAs on banks' profits and lending
prowess
o The efficiency of a bank is not always
reflected only by the size of its
balance sheet but also by the level of
return on its assets
o NPAs do not generate interest income,
but at the same time banks are
required to make provisions from their
current profits.
The impact of NPAs on the return on
assets
They erode current profits through
provisioning requirements
They result in reduced interest income
They affect profits and accretion to
capital funds and capacity to increase
good quality risk assets in future, and
They limit recycling of funds, set in
asset-liability mismatches, etc
Indirect Impact
Reduction in lending rates is made
difficult
Affect risk taking ability which
ultimately affect competitiveness
Lack of market competitiveness results
in slump in credit expansion.
The cost of poor quality loans is shifted
to bank customers through higher
spreads.

Management of NPAs
The essential component of a sound
NPA management system is
Quick identification of non-
performing advances,
Their containment at minimum levels
and
Ensuring that their impingement on
the financials is minimum.

Essential aspects of NPA management
Excessive reliance on collateral should
not be sole criterion for sanction
Sanctions above certain limits should
be through Committee ('Approval
Grid)
Banks running after the same
borrower/borrower groups to lend
beyond the prescribed exposure
limits, which is fraught with risk
Banks should rather manage within the
appropriate exposure limits
A linkage to net owned funds also needs to
be developed to control high leverages at
borrower level
Exchange of credit information among
banks help them to avoid possible NPAs.
Excellent appraisal but no control at disbursement
stage over compliance with the terms of sanction.

Close monitoring of the account particularly the
larger ones is the primary solution.

Loan review mechanism is a tool to bring about
qualitative improvement in credit administration.

Banks should follow risk rating system to reveal the
risk of lending.
The risk-rating process should be different from
regular loan renewal exercise and should be
carried out at regular intervals.

Banks should ensure that sanctioning of further
credit facilities is done only at higher levels.

A quick review of all documents originally obtained
and their validity should be made.

A phased programme of exit from the account
should also be considered.
Identification of Potential NPAs
Signals: Transaction related
Persistent irregularity in accounts
Defaults in repayment obligations
Devolvement of LC liabilities
Invocation of guarantees
Frequent resort to ad-hoc limits etc.

Identification of Potential NPAs- contd
Activity related
Rejection of products
Idle machineries
Decline in no. of shifts/workers
Inventory pile up
Delays in receivables collection
Increased dependence on job works
Technological obsolescence etc.
Factors leading to NPAs- General
Poor Credit Management
Faulty lending policy/lower entry point
norms/bench mark ratio
Absence of portfolio concentration
limits- industry/region specific etc
Excessive centralisation or
decentralisation of lending authority
A perfunctory financial analysis of
borrower
Poor loan review system
Inadequate Monitoring & Follow up
Misuse of authority
He is an alright guy syndrome
Inadequate expertise in the sector
financed
Failure to act on inspection/audit
irregularities

An excessive reliance on collaterals
In-frequent customer contact
Absence of loan supervision
Poor control over loan documentation
Excessive lending

Absence of standard rating scale to
watch the migration of borrowers from
one rating to the other
Ineffective MIS system
Factors leading to NPAs- External

Raw Materials shortage
Power shortage
Price escalation
Excess capacities
Monsoon dependency
Natural calamities
Social unrest
General Economic recession
Government Policies
Internal-Borrower specific
Management inefficiency
Diversion of funds & Misutilisation of funds
Faulty project planning resulting in time/cost
over run or Wrong technology
Product failing to capture market
Strained labour relations
Willful default
Product obsolescence

Prognosis-Strategies
Preventive

Detective

Corrective

Prevention is better than Cure
In any financial institution,
NPAs are inevitable in the loan
portfolio. But efforts should be
made to maintain a reasonable
level of NPAs.

Final Thoughts
Ships are safest when they are
anchored at the Port
But that is NOT the place where they
are supposed to be
Similarly Banking is also NOT a no risk
business
But it is..
Calculated Risk Taking

Thank You

dmahabal@hotmail.com

Credit Appraisal & Monitoring - Session - Vii: Management of Npas

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