3. To check continuously if the loan policy is
being adhered to
To identify problems in accounts, even at the
incipient stage
To assess the bank’s exposure to credit risk
To assess the bank’s future capital
requirements
4
4. To obtain and scrutinize the financial
statements of the borrowers periodically
To ensure compliance of covenants (sanction
terms) and notice violations immediately, if any
To periodically ensure that the security coverage
for the loans granted doesn’t get diluted
To notice payment defaults immediately
To identify genuine problems of the potential
borrowers and institute timely remedial action
5
5. Macro level
◦ Economic developments that may have an impact on the industry
◦ Industry development that may have an impact on the borrower
Borrower’s level
◦ Financial health of the borrower – over/ under borrowed?
◦ Borrower’s repayment record
◦ Quality/ condition/ value of security offered – primary & collateral
◦ Completeness of documentation as per legal requirements
◦ Adherence to loan covenants
6
6. Categories of sickness
◦ Sickness at birth
Project itself becomes infeasible due to faulty assumptions or change in
environment
◦ Induced sickness
Incompetence in management or willful default
◦ Genuine sickness
Circumstances beyond the borrower’s control
Happens in spite of the borrower’s sincere efforts to avert the situation
7
7. Effect of financial distress
◦ Prolonged period of lack of profitability
◦ Decay in cash flows – not able to meet the current
liabilities/ high level of unrealizable receivables
◦ Providing inadequate depreciation to the fixed assets –
assets losing market value not getting reflected in the
balance sheet
◦ Rates of return from investments drop below the cost of
capital
Issues to be tackled
◦ What are the signals of financial distress?
◦ Can the banks detect the signs of distress early enough?
◦ Can financial distress be predicted?
8
8. Warning signs Endogenous(Originating) from the firm
Management Related
◦ Lack of technical expertise
◦ Failure to control cost
◦ Fraud
◦ Poor capacity utilization
Technology Related
◦ Wrong choice of technology
◦ Choice of obsolete process
Product related
◦ Over estimating demand
◦ Demand for product fails
◦ Improper pricing
Financial management related
◦ Underestimating the project cost
◦ Inadequate working capital
◦ Financial control are weak 9
9. Warning signs Exogenous(Originating Externally) to
the firm
1) At the project implementation stage
- Currency risk
- Upward revision of import duties or excise duty may
escalate the project cost
- Delay in the receipt of approval for the project from the
government
- Force major event
2) At the production stage
- Non availability of raw material
- Power cuts, transport bottlenecks
- technological changes
-force major events
10
10. Warning signs Exogenous(Originating Externally)
to the firm
3) At the sales/marketing stage
- reduction in demand
- withdrawal of degree of government protection
- price cutting by competitors
- availability of cheaper alternatives
- economic downturn
4) Financial Management
- Non availability of adequate credit from bank
- delay in release of adequate of funding by the
banks 11
11. Continuous irregularities in Cash Credit/ Overdraft
accounts – inability to maintain margin/ frequent
drawings exceeding the sanctioned limits/ periodical
interest debited remaining unrealized
Balance in CC account always at the maximum
Default/ delay in payment of installments in Term loan
accounts
Non-submission/ delay in submission / incorrect
submission of stock statements and other control
statements
Attempts to divert sales proceeds through accounts of
other banks
Downward trend in credit summations (sales turnover)
Frequent return of cheques/ bills
12
12. Decline in production/ sales/ profit
Rising level of inventories – slow moving of finished goods
Large and longer outstanding in bills accounts
Large and longer outstanding of credit documents
negotiated through bank and frequent return of the same
Failure to pay statutory liabilities
Diverting the bank’s finance – utilizing the funds for purpose
other than running the business
Non cooperation – not furnishing required information/ delay
in meeting payment commitments etc.
13
13. Workout procedure to be adopted by the banks to ensure high
recovery rates
◦ Intensify the collection process through letters/ telephone calls/ personal
visits/ inspections
◦ Build an appropriate team from internal or external resources to enforce an
effective monitoring system, which may involve legal action
◦ Assess available alternative solutions taking into account the costs involved –
whether to go in for restructuring or loan sales or legal action or write off
Banks basically have two choices for the workout
◦ Restructure the problem (Rehabilitation) for potentially viable sick units within
stipulated time frame – 3 to 6 months
◦ Liquidate the credit
14
14. Broad parameters for grant of relief
Term Loans
◦ Waiver of penal interest and additional charges, if any during the
intervening period
◦ Interest on term loan may be reduced, if necessary; reduced interest
rates are prospective
◦ Unpaid interest may be segregated and funded; repayment schedule
for the same may be fixed (within 3 years normally); no interest to be
charged on unpaid interest
◦ Fresh term loans may be sanctioned for revival – repayment period to
be fixed between 5 to 7 years
15
15. Cash Credit
◦ Waiver of penal interest and additional charges, if any during the
intervening period
◦ Unpaid interest in Cash Credit account may be segregated and funded;
this funded loan, which is a clean loan, can be extended as a term loan
(FITL) without interest – to be repaid within 3 to 5 years
◦ A part of working capital loan may be unsecured without any primary
security; this portion may be converted as ‘working capital term loan
(WCTL)’ to be repaid in installments; interest on this loan may be at a
concessional rate
16
16. Cash losses
Even after rehabilitation, till the firm reaches the
break even period, the cash losses incurred by the
firm may be funded by banks
Additional loan assistance
Additional working capital loan may be granted for
carrying on the operations at a concessional
interest (comparable to prime lending rate – PLR)
Additional loan for meeting capital expenditure, if
any, may be granted as contingency assistance, at a
concessional rate
17
17. Start-up expenses & Margin for working capital
The ailing firm tends to have liquidity problems and hence to
ensure uninterrupted operations, the bank can fund for
making payments to the pressing creditors/ statutory
liabilities and to provide margin for WC loans; such payments
may be treated as part of the term loans for start –up
Promoters’ contribution
Fresh infusion of funds from the borrowers is required to
ensure their involvement – at least 20 to 30% of the total term
loan requirement should be contributed by the promoters
Concessions from other agencies
State Government – SLIIC/ SFCs/ SIDBI
Central Government – BIFR/ IDBI
18
18. Rights of the rehabilitating bank
◦ Right of Review - to reassess the facilities offered - for example, to
revise the interest rate upwards etc.
◦ Right of Recompense – to recoup the interest and other monetary
sacrifices, once the firm generates adequate positive cash flows
Cases where rehabilitation should not be considered
◦ If the firm’s sickness is due to the following, the bank should not go in
for rehabilitation but should take efforts for recovery of the dues
Mismanagement
Willful default
Unauthorized diversion of funds
Dispute among partners/ promoters
19
19. A concrete step was taken by RBI to manage
credit risk in banks, in the year 1998, by way of
introducing ‘Prudential norms for Asset
Classification, Income Recognition and
Provisioning’– initiated from Narasimham
Committee Recommendations of 1991and 1998
on financial sector reforms
RBI gave instructions to all banks to classify
assets (loans and advances) under certain
categories; it also includes leased assets
Loans which do not generate income to the
bank are to be classified as ‘Non-performing
Assets’ (NPA)
20
20. NPA is a loan where
◦ Interest and/or installment of principal remain overdue for a
period of more than 90 days in respect of term loans
◦ Account remains out of order in respect of overdraft/ cash
credit accounts for more than 90 days
◦ Bill remains overdue for a period of more than 90 days in
respect to bills purchased/ bills discounted accounts
◦ Interest and/or installment of principal remain overdue for two
crop seasons, in respect of crop loans granted for short
duration crops
◦ Interest and/or installment of principal remain overdue for one
crop season, in respect of crop loans granted for long duration
crops
◦ The amount of liquidity facility remains outstanding for more
than 90 days in respect of securitization transaction
◦ Derivative contracts, whose overdue receivables remain unpaid
for more than 90 days
21
21. Income recognition – income from NPA is not to be recognized on accrual
basis but is booked as income only when it is actually received; hence
◦ Banks should not charge interest on any NPA
◦ Unrealized interest, if any, should be reversed or provided for
◦ Unrealized finance charge component of finance income in case of
leased assets should be reversed or provided for
◦ Interest realized on NPAs may be taken to income account provided the
credits in the accounts towards interest are not out of fresh/additional
credit sanctioned to the borrower
22
22. Asset classification – NPAs are classified based on i) period
for which the asset has remained as NPA and ii) the realizability of
dues
The following are classification norms
◦ i) Sub-standard asset – an asset, which has remained NPA
for a period of less than or equal to 12 months
◦ ii) Doubtful asset – an asset, which has remained in the
sub-standard category for a period of more than 12
months
◦ 1 to 3 years
◦ Iii) Loss asset – an asset which is considered uncollectable
and hence continuance as a bank asset is not warranted
◦ More than 3 years
The assets, which are not classified as NPAs i.e. accounts which are
conducted well are called ‘Standard Assets’
23
23. Provisioning norms – adequate provision has to made by the
banks for their NPA accounts
◦ Loss assets
They have to be written-off or provision has to be made for 100% of the
outstanding amount
◦ Doubtful assets
Provision of 100% to the extent of loan not covered by realizable security
(unsecured portion)
Provision 25% to 100% for the portion of loans covered by realizable
security as under (secured portion)
Up to 1 year – 25%
1 to 3 years – 40%
More than 3 years – 100%
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24. Provisioning norms
◦ Sub-standard assets
General provision of 15% on the total outstanding should be made ( without
making any allowance for ECGC Guarantee cover and securities available)
The unsecured exposures would attract an additional provision of 10%
constituting to 25% of the outstanding balance
◦ Standard assets
Direct advances to Agriculture, Small & Micro enterprises sectors – 0.25%
Advances to commercial real estate sector – 1.00%
Advances to commercial real estate residential housing sector – 0.75%
All other advances – 0.40%
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