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Non Performing Assets

Non Performing Assets

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  • 2. 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 ”
  • 3. Indian Economy and NPA’s
    • The Indian Economy has been much affected due to lack of infrastructure facilities, sticky legal system, cutting of exposures to emerging markets by FII’s,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 FII’s in India hold NPA’s worth around Rs 1,10,000 crores.
  • 4. Global Developments and NPA’s
    • 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 borrower’s inability to repay it .
  • 5. 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 FII’s 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.
  • 6. Why NPA’s have become an issue for banks and FII’s in India?
    • The origin of the problem of burgeoning NPA’s 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.
  • 7. Resolution of NPA’s
    • At present, local banks are saddled with the management of NPA’s 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 NPA’s have strained their resources.
    • The unavailability of new loans has therefore hindered economic growth and development.
  • 8. Contd……
    • ADB intends to assist local banks resolve their problems with NPA’s by facilitating the financing of SPV’s 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.
  • 9. Indian Banking systems – some hard facts
    • Gross NPA’s of the financial system is placed at Rs 1,35,000 crore, of which, over Rs 98,000 crore pertains to Scheduled Commercial Banks (SCB’s) and FII’s.
    • Gross NPA’s showed increasing trend over the yrs and accretion to gross NPA’s by SCB’s during last two fiscals were Rs 24,824 crore(2001-02) & Rs 21,862 crore(2002-03).
  • 10. 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 NPA’s 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 NPA’s.
  • 11. 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.
  • 12. 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.
  • 13. Measures to reduce NPA’s
    • 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.
  • 14. High cost of funds due to NPA
    • Quite often genuine borrowers face difficulties in raising funds from banks due to mounting NPA’s.
    • 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 don’t pay the dues, then the banks can takeover the possession of assets & also takeover the management of the company.
  • 15. 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
  • 16. 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
  • 17. 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
  • 18. At The Mercy Of Balance Sheet
    • Operating margin
    • Current ratio
    • cash flow
    • Fund flow
  • 19. 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
  • 20. 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
  • 21. 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
  • 22. Credit Risk Techniques
    • Quantitative
      • Ratio analysis
      • Fund flows
      • Mathematical models
    • Qualitative
      • Policies
      • Procedures
      • Concentration
  • 23. 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
  • 24. 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
  • 25. Getting The Combination Right
    • Credit metrics works on the statistical concepts like probability, means, and standard deviation, correlation, and concentrations
  • 26. 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
  • 27. 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.
  • 28. 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
  • 29. ARCIL Objectives
    • Convert NPA into performing assets
    • Act as nodal agency for NPA resolution
    • Create a vibrant market for NPA estructured debt
    • Re-energize the financial sector.
  • 30. Transaction Structure
  • 31. Transaction Structure- Stage-2
  • 32. 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
  • 33. Indian Financial System -2003-04
  • 34. 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)
  • 35. 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.
    • 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.
  • 37. 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.
  • 38. 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
  • 39. MANAGING NPA- Resolution Strategy
    • (II) Asset Management Strategy
    • - Disposition by strip sale
    • - Change in management
    • - Takeover of assets
    • - Legal route / Foreclosure
  • 40. 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.
  • 41. 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
  • 42. 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
    • - 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)
    • - 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
  • 45. Key Isuues before ARCs
    • Valuation of NPA
    • Debt Aggregation
    • Legal & Regulatory
  • 46. 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.