Former RBI Governor Mr. Reghuram Rajan once said, The fundamental lesson of
every situation of banking stress in recent years across the world is to recognise and flag the problem loans quickly and deal with them...
Forbearance is ostrich –like behaviour, hoping the problem will go away. It is
not realism but naiveté. The incidents of growing NPAs in banks and financial
institutions are causing great concern. The effective remedy of arresting the
trend is to go to the root cause of the cancer of NPA and removing it.
general perception is that the banks are always right and the borrowers are the
villains because they do not follow financial discipline forgetting the fact
that the more important job of credit sanctioning and monitoring is practically
being ignored or overlooked by banks and FIs due to ignorance, lack of knowledge
and expertise or utter indifference and callousness on the part of the employees
of all categories. The following anecdotes are examples of such apathy on the
part of the bank while sanctioning a term loan and working capital.
A term loan of Rs.25 crores was sanctioned to an individual for the purchase of
land who was the managing director of a manufacturing company enjoying huge
limits which was also facing financial stress. The loan was to be cleared within
one year but the bank did not disclose how they appraised and assessed the
repayment of such a huge amount within a year since the individual's financial
status did not reveal that he can service the interest and repay the debt within
the stipulated time.
Under the circumstance the borrower has either to divert
fund from his company or borrow heavily from other sources or sell the property
he purchased even on a distressed sale. He did divert fund from his company and
also borrowed heavily to clear the loan. But in the process the Company was
classified as NPA and legal measures were initiated. The loan was sanctioned by
the Board of the bank.
Who is responsible for this NPA?
Yet in another case, two individual short-term loans of Rs. 5 crores each were
sanctioned against immovable properties to two directors of a Company which was
enjoying huge limits for their manufacturing activities and the Company was
already under stress. The loans were to be cleared within three months through
a bullet -payment.
The purpose of the loan was not mentioned but the proceeds of
the loans were diverted to clear the arrears of interest and installments in the
loan accounts sanctioned to the Company. The bank did not furnish the documents
executed by the borrowers or made available how the assessment and appraisal
were made regarding the repayment capacity of the borrowers.
financial status also did not reveal their ability to repay the loan. The result
was that both the loans were classified as NPA along with the Company's account
and legal action were initiated.
Who is responsible for the classification of
the accounts as NPA?
Similarly, under a multiple banking transaction, two banks sanctioned separate
term loans to a manufacturing Company and they also arrived at the quantum of
working capital required. While the term loans were disbursed with delay in a
phased manner because of which the project could not be completed as per
schedule and there was a cost escalation, the working capital was never
sanctioned even though assessed by the banks because of the lack of
understanding between the two lender banks as to the quantum to be shared.
Instead of rescheduling the term loan according to the revised schedule of
commencement of commercial production and sanction and release of working
capital as per RBI norms, the banks sent notices of recall and assigned the
debts to two different Asset Reconstruction Companies respectively. The two ARCs
also without undertaking any due diligence and any reconstruction programs,
initiated legal proceedings against the borrower Company without complying with
RBI guidelines and Government policies.
Who is responsible for such a state of
affair?Prevention is better than cure
says the old saying. It is very much true in
the case of NPA also. But the pertinent question is whether the banks and
Financial Institutions take such steps to prevent the account slipping into NPA.
RBI issued a circular DBS.CO.OSMOS/ B.C./ 4 /33.04.006/2002-2003 dated
September 12, 2002 addressed to The Chairman/Managing Director /Chief Executive
Officer of All Commercial Banks (Excluding RRBs) on Study on preventing slippage
of NPA accounts wherein they have recommended certain steps to be taken to
prevent slippage of accounts to NPA status and expected that banks will work
out their strategic response in keeping with the broad thrust of these
guidelines. But the big question is whether the banks and financial
institutions have taken any strategic response
as expected by RBI. That is a
point to be pondered over.
RBI exhorts the banks and FI, Recognize the problem early:
Invariably, by the
time banks start their efforts to get involved in a revival process, it's too
late to retrieve the situation - both in terms of rehabilitation of the project
and recovery of bank's dues. Identification of weakness in the very beginning
(i.e., when the account starts showing first signs of weakness regardless of the
fact that it may not have become NPA) is imperative. Assessment of the potential
of revival may be done on the basis of a techno economic viability study.
Restructuring should be attempted where, after an objective assessment of the
viability and promoter's intention (and his stake), banks are convinced of a
turnaround within a scheduled timeframe.
The strategy for management of NPAs may be governed by the
circumstances connected to each individual case. Generally, the NPA is more
likely to be resolved in terms of recovery if the company is in operation. For
this to be effective there must be a system of identifying the weakness in
accounts at an early stage. In the aforesaid cases, the very assessment and
appraisal of the banks were faulty and lack of vital decision making with regard
to sanction and timely release of banking facilities created the aforesaid NPA
The actions of the banks are in gross violations of banking principles
and practices and RBI guidelines. and Under the Early Alert system, for
internal monitoring purpose, banks may designate a time limit for overdue
accounts to determine the threshold for a proactive intervention - well before
the account becomes NPA.
Banks are expected to undertake an exercise to
understand the impact of their own actions at the sanction level itself and
probe into early warning and alert system based on the symptoms of the impending
problems so as to enable them to take preventive actions against the account
A close look at the way the banks and financial institutions declare the
accounts as NPA shows that the very fundamental principles as envisaged by RBI
in their preamble are being overlooked which states:
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 so as to move towards greater consistency and
transparency in the published accounts.
Further, RBI also expects:
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.
RBI again exhorts the banks and financial
Banks are urged 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.
Thus, it is
evident that the crux of the problems of recovery of loans in the banks and
financial institutions lay on the aforesaid facts as stated by RBI in their
guidelines. In the aforesaid first two cases, the appraisal and assessment of
cash flow was not done realistically and the loan was sanctioned purely on the
basis of security and not for productive purposes. The third case was purely
lack of decision making and sanction and release of funds at the right time.
Reserve Bank of India issued a circular DBOD. No. BP.BC/ 42/21.04.048/2012-13
dated September 14, 2012 addressed to The Chairman and Managing Director/ Chief
Executive Officer of All Scheduled Commercial Banks (Excluding RRBs) on NPA
Management - Requirement of an Effective Mechanism and Granular Data which
states, 2. As mentioned therein, asset quality of banks is one of the most
important indicators of their financial health.
However, it has been observed
that existing MIS on the early warning systems of asset quality, needed
improvement. Banks are, therefore, advised that they should review their
existing IT and MIS (Management Information system) framework and put in place a
robust MIS mechanism for early detection of signs of distress at individual
account level as well as at segment level (asset class, industry, geographic,
Such early warning signals should be used for putting in place an
effective preventive asset quality management framework, including a transparent
restructuring mechanism for viable accounts under distress within the prevailing
regulatory framework, for preserving the economic value of those entities in all
The banks' IT and MIS system should be robust and able to generate reliable and
quality information with regard to their asset quality for effective decision
RBI further states:
The asset quality of banks
is one of the most important indicators of their financial health. It also
reflects the efficacy of banks' credit risk management and the recovery
environment. It is important that the signs of distress in all stressed accounts
are detected early and those which are viable are also extended restructuring
facilities expeditiously to preserve their economic value. During annual
financial inspection (AFIs), it has been observed that the restructuring
facilities are not readily extended to small accounts.
To improve the banks' ability to manage their non-performing assets (NPAs) and
restructured accounts in an effective manner and considering that almost all
branches of banks have been fully computerised, it is proposed:
- to mandate banks to put in place a robust mechanism for early detection
of signs of distress, and measures, including prompt restructuring in the
case of all viable accounts wherever required, with a view to preserving the
economic value of such accounts.
Sensitizing branch level functionaries: Banks need to sensitize their Branch
level functionaries of the requirements of the MSE sector and hold training
programs to improve the awareness of guidelines pertaining to the sector, at
The pertinent point that is emphasized is the Sensitizing branch level
functionaries of banks. But the factual position in the banks is that majority
of branch functionaries and many of the zonal level and Head Office level
functionaries also including higher level executives lack the required
knowledge and expertise about law and practice of banking and many of them even
may not know about the existence of such RBI directives and notifications.
In the ultimate analysis gathering the required data regarding project to be
financed and their credit assessment and appraisal based on the data available
and if sanction of credit facilities is undertaken on a realistic, pragmatic and
practical way and followed by effective and efficient credit monitoring of loan
account would lead to better management of credit.
Besides, understanding the problems and predicament faced by the borrowers and
taking timely decision and implement the plan of action to prevent the account
becoming NPA would certainly reduce the incidents of account becoming NPA and if
the account becomes NPA, then taking remedial measures without delay would
ensure the rehabilitation / restructuring of the account based on a pragmatic
and realisable cash flow which would certainly reduce and contain the incidents
of account becoming NPA.
Written By: T. R. Radhakrishnan -
Banking & Management Consultant,
Facilitator: DRT & SARFAESI Cases and Consumer Forum, H. R. Trainer: Corporates,
Colleges & Schools, & Freelance Writer,
Address: No. 8, Morya Gardens, Kanadia Road, Indore.452016 (Madhya Pradesh)
E-mail: [email protected]
, Mobile: (0)9229248048