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.

The 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.

The individual's 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.

RBI states:
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 accounts.

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 becoming NPA.

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 institutions:
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, size, etc.).

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 segments...

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 making.

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 branch level.

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,
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