Over the next ten years Asia could emerge as the world's growth engine, led by China and India, and fueled by an inflow of global capital, technology transfer, an export boom, and increased domestic consumption. For Asia to realize its promise, the region's reform-minded governments and regulators, companies and businesses, and lenders must move aggressively to clean up $2 trillion in non-performing loans, a legacy of the 1990s that continues to be a drag on the region's economies.
Such a vast volume of Non-performing Assets of the banks is the main consequence of economic crisis that took place in many Asian countries. At the same time non-performing assets of the banks in many Asian countries can be seen as the probable cause of the potential banking crisis that could be occurred in the future in these countries. In order to prevent such banking crisis, the Non-Performing Assets of the banks are required to be managed and disposed off effectively. Hence management of non-performing assets held by the banks has become an important function in today's financial world
This project has attempted to provide a more comprehensive approach to management of and resolution to the problem of Non Performing Assets (hereafter referred to as NPAs) of banks This project has also touched some important areas in the performance evaluation measures used by banks and credit process in the banks that help identify NPAs at micro level and macro level. Further it has explained various NPA valuation approaches and techniques for resolution of NPAs.
The issue of non-performing assets (NPAs) in India and some other Asian countries (viz. China, Thailand, Korea and Japan) has been discussed at length in the following parts of the project. The causes behind the NPA problem and the methods used to resolve this issue across these countries have been analyzed and discussed extensively.
'An asset, including a leased asset, becomes nonperforming when it ceases to generate income for the bank.'
For a bank, assets are loans that it gives to individuals and companies and gets regular income from it in the form of interest. When these assets stop generating regular cash flow (or become non-performing), they are known as NPAs.
A debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The non performing asset is therefore not yielding any income to the lender in the form of principal and interest payments.
Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by The Reserve Bank of India. An asset, including a leased asset, becomes nonperforming when it ceases to generate income for the bank. A NPA is a loan or an advance where Interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan. Earlier assets were declared as NPA after completion of the period for the payment of total amount of loan and 30 days grace. In present scenario, assets are declared as NPA if none of the installment is paid till 180 days i.e. six months in respect of term loan.
With effect from March 30, 2004, a non performing asset (NPA) has been classified as a loan or an advance where:
i. Interest and/or installments of principal remain overdue for a period of more than 90 days in respect of a term loan;
ii. The account remains out of order for a period of more than 90 days in respect of an overdraft / cash credit (OD / CD);
iii. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted;
iv. Interest and/ or installments of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of advance granted for agricultural purpose; and
v. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.
'Out of Order' status
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'.
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.
In 1992, RBI introduced the prudential norms for income recognition, asset classification & provisioning ' IRAC norms in short ' in respect of the loan portfolio of the Co-operative Banks. The objective was to bring out the true picture of a bank's loan portfolio. The fallout of this momentous regulatory measure for the management of the CBs was to divert its focus to profitability, which till then used to be a low priority area for it. Asset quality assumed greater importance for the CBs when maintenance of high quality credit portfolio continues to be a major challenge for the CBs, especially with RBI gradually moving towards convergence with more stringent global norms for impaired assets.
The quality of a bank's loan portfolio can impact its profitability, capital and liquidity. Asset quality problems are at the root of other financial problems for banks, leading to reduced net interest income and higher provisioning costs. If loan losses exceed the Bad and Doubtful Debt Reserve, capital strength is reduced. Reduced income means less cash, which
can potentially strain liquidity. Market knowledge that the bank is having asset quality problems and associated financial conditions may cause outflow of deposits. Thus, the performance of a bank is inextricably linked with its asset quality. Managing the loan portfolio to minimize bad loans is, therefore, fundamentally important for a financial institution in today's extremely competitive and market driven business environment. This is all the more important for the CBs, which are at a disadvantage of the commercial banks in terms of professionalized management, skill levels, technology adoption and effective risk management systems and procedures.
Management of NPAs begins with the consciousness of a good portfolio, which warrants a better understanding of risks in lending. The Board has to decide a strategy keeping in view the regulatory norms, the business environment, its market share, the risk profile, the available resources etc. The strategy should be reflected in Board approved policies and procedures to monitor implementation. The essential components of sound NPA management are:
1) Quick identification of NPAs,
2) Their containment at a minimum level,
3) Ensuring minimum impact of NPAs on the financials.
How is it classified?
If a loan installment is not paid for three months or 90 days, it is considered as an NPA. For example, if you have taken an education loan and have been unable to repay the interest or the principal amount for three months, the bank from where you have taken this loan will record it in its books as NPA. If an asset remains non-performing for a period less than or equal to 12 months, it would be classified as a sub-standard asset. These assets attract a provisioning, the money that a bank should set aside to cover potential losses, of 15%. If an asset remains in the sub-standard category for 12 months, it would be considered a doubtful asset with 25-100% provisioning. When an asset is identified uncollectable then it is a loss asset which calls for 100% provisioning.
When do NPAs rise?
To tame inflation, the Reserve Bank of India (RBI) has tightened the monetary policy 13 times since March 2010. When RBI increases its key policy rates, the banks raise lending rates or an increase loan tenor is possible. Soaring inflation and rising rates have seen the monthly budgets of many households go upside down. This has an immediate impact on the equated monthly installments (EMIs). When many borrowers default, especially the ones with large credit dues, a bank's profitability is hit. It needs to be noted here that a majority of NPAs for banks come from small and medium enterprises and companies.
Income Recognition Policy
The policy of income recognition has to be objective and based on the record of recovery. Internationally income from non-performing assets (NPA) is not recognized on accrual basis but is booked as income only when it is actually received. Therefore, the banks should not charge and take to income account interest on any NPA.
However, interest on advances against term deposits, NSCs, IVPs, KVPs and Life policies may be taken to income account on the due date, provided adequate margin is available in the accounts.
Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding debts should be recognized on an accrual basis over the period of time covered by the re-negotiated or rescheduled extension of credit.
If Government guaranteed advances become NPA, the interest on such advances should not be taken to income account unless the interest has been realized.
Reversal of income
If any advance, including bills purchased and discounted, becomes NPA, the entire interest accrued and credited to income account in the past periods, should be reversed if the same is not realized. This will apply to Government guaranteed accounts also.
In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed with respect to past periods, if uncollected.
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.
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.
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