Adverse Effects of Npa on the Working of Commercial Banks

Between 01.04.93 to 31.03.2001Commercial banks incurred a total amount of Rs.31251 Crores towards provisioning NPA. This has brought Net NPA to Rs.32632 Crores or 6.2% of net advances. To this extent the problem is contained, but at what cost? This costly remedy is made at the sacrifice of building healthy reserves for future capital adequacy. The enormous provisioning of NPA together with the holding cost of such non-productive assets over the years has acted as a severe drain on the profitability of the PSBs. In turn PSBs are seen as poor performers and unable to approach the market for raising additional capital. Equity issues of nationalised banks that have already tapped the market are now quoted at a discount in the secondary market. Other banks hesitate to approach the market to raise new issues. This has alternatively forced PSBs to borrow heavily from the debt market to build Tier II Capital to meet capital adequacy norms putting severe pressure on their profit margin, else they are to seek the bounty of the Central Government for repeated Recapitalisation.

Considering the minimum cost of holding NPAs at 7% p.a. (reckoning average cost of funds at 6% plus 1% service charge) the net NPA of Rs.32632 Crores absorbs a recurring holding cost of Rs.2300 Crores annually. Considering the average provisions made for the last 8 years, which works out to average of Rs.3300 Crores from annum, a sizeable portion of the interest income is absorbed in servicing NPA. NPA is not merely non-remunerative. It is also cost absorbing and profit eroding. In the context of severe competition in the banking industry, the weak banks are at disadvantage for leveraging the rate of interest in the deregulated market and securing remunerative business growth. The options for these banks are lost. “The spread is the bread for the banks”. This is the margin between the cost of resources employed and the return there from. In other words it is gap between the return on funds deployed(Interest earned on credit and investments) and cost of funds employed(Interest paid on deposits). When the interest rates were directed by RBI, as heretofore, there was no option for banks. But today in the deregulated market the banks decide their lending rates and borrowing rates. In the competitive money and capital Markets, inability to offer competitive market rates adds to the disadvantage of marketing and building new business.

In the face of the deregulated banking industry, an ideal competitive working is reached, when the banks are able to earn adequate amount of non-interest income to cover their entire operating expenses i.e. a positive burden. In that event the spread factor i.e. the difference between the gross interest income and interest cost will constitute its operating profits. Theoretically even if the bank keeps 0% spread, it will still break even in terms of operating profit and not return an operating loss. The net profit is the amount of the operating profit minus the amount of provisions to be made including for taxation. On account of the burden of heavy NPA, many nationalised banks have little option and they are unable to lower lending rates competitively, as a wider spread is necessitated to cover cost of NPA in the face of lower income from off balance sheet business yielding non-interest income. The following working results of Corporation bank an identified well managed nationalised banks for the last two years and for the first nine months of the current financial year, will be revealing to prove this statement- Table -6 (part-1) …………Performance of Corporation Bank …….(Amount in Crores).. Performance indicator| Year ended Mar. 2000| Year ended Mar. 2001| 9 months Apr.Decr.2001| Earnings – Non-interest| 270.81| 292.09| 285.85|

Operating expenses| 303.99| 341.36| 280.52|
Difference| -33.18| -49.27| 5.33|
Non-interest income fully absorbs the operating expenses of this bank in the current financial year for the first 9 months. In the last two financial years, though such income has substantially covered the operating expenses (between 80 to 90%) there is still a deficit left. Now what are the interest earnings and expenses of Corporation Bank during this period?

Table -6 (part-1) Corporation Bank -Interest Earnings and Expense……………….. (Amount in Crores) Performance indicator| Year ended Mar. 2000| Year ended Mar. 2001| 9 months Apr.Decr.2001| Earnings – Interest Income|
1604.39| 1804.54| 1458.33|

Exp.-Interest expenses| 1146.09| 1223.21| 981.45|
Interest spread| 458.30| 581.33| 476.88|
Operating Profit| 425.12| 482.21| 532.06|
Provisions| 192.68| 270.22| 219.48|
Net Profit| 232.44| 261.84| 262.73|
The strength of Corporation Bank is identified by the following positive features: i. It’s sizeable earnings under of non-interest income substantially/totally meets its non-interest expenses .

ii. Its obligation for provisioning requirements is within bounds. (Net NPA/Net Advances is 1.92%) It is worthwhile to compare the aggregate figures of the 19 Nationalised banks for the year ended March 2001, as published by RBI in its Report on trends and progress of banking in India. Table 7- Nationalised banks operational statistics……….. (Amount in Crores) Performance indicator| Year ended Mar. 2000| Year ended Mar. 2001| Earnings – Non-interest| 6662.42| 7159.41|

Operating expenses| 14251.87| 17283.55|
Difference| -7589.45| -10124.14|
Earnings – interest income| 50234.01| 56967.11|
Exp.-Interest expenses| 35477.41| 38789.64|
Interest spread| 14756.60| 18177.47|
Intt. On Recap bonds| 1797.88| 1795.48|
Operating Profit| 5405.27| 6257.85|
Provisions| 4766.15| 5958.24|
Net Profit| 639.12| 299.61|

Interest on Recapitalisation Bonds is an income earned from the Government, who had issued the Recapitalisation Bonds to the weak banks to sustain their capital adequacy under a bailout package. The statistics above show the other weaknesses of the nationalised banks in addition to the heavy burden they have to bear for servicing NPA by way of provisioning and holding cost as under: i. Their operating expenses are higher due to surplus manpower employed. Wage costs to total assets is much higher to PSBs compared to new private banks or foreign banks. ii. Their earnings from sources other than interest income are meagre. This is due to failure to develop off balance sheet business through innovative banking products. How NPA Affects the Liquidity of the Nationalised Banks?

Though nationalised banks (except Indian Bank) are able to meet norms of Capital Adequacy, as per RBI guidelines, the fact that their net NPA in the average is as much as 7% is a potential threat for them. RBI has indicated the ideal position as Zero percent Net NPA. Even granting 3% net NPA within limits of tolerance the nationalised banks are holding an uncomfortable burden at 7.1% as at March 2001. They have not been able to build additional capital needed for business expansion through internal generations or by tapping the equity market, but have resorted to II-Tier capital in the debt market or looking to recapitalisation by Government of India. How NPA Affects the Outlook of Bankers towards Credit Delivery The fear of NPA permeates the psychology of bank managers in the PSBs in entertaining new projects for credit expansion. In the world of banking the concepts of business and risks are inseparable. Business is an exercise of balancing between risk and reward. Accept justifiable risks and implement de-risking steps.

Without accepting risk, there can be no reward. The psychology of the banks today is to insulate themselves with zero percent risk and turn lukewarm to fresh credit. This has affected adversely credit growth compared to growth of deposits, resulting a low C/D Ratio around 50 to 54% for the industry. The fear psychosis also leads to excessive security-consciousness in the approach towards lending to the small and medium sized credit customers. There is insistence on provision of collateral security, sometimes up to 200% value of the advance, and consequently due to a feeling of assumed protection on account of holding adequate security (albeit over-confidence), a tendency towards laxity in the standards of credit appraisal comes to the fore. It is well known that the existence of collateral security at best may convert the credit extended to productive sectors into an investment against real estate, but will not prevent the account turning into NPA. Further blocked assets and real estate represent the most illiquid security and NPA in such advances has the tendency to persist for a long duration. Nationalised banks have reached a dead-end of the tunnel and their future prosperity depends on an urgent solution of this hovering threat.

Other Effects
There are many instances where a borrower had been a very valued customer of the Bank, but becomes vulnerable after being declared as NPA. The SME’s are still far more in a pitiful condition. NPA (Non Performing Asset) is an industrial phenomenon which indicates industrial sickness. The national growth of a country particularly country like India depends upon the growth and health of SME’s. The so called banking reform are targeted towards killing the Sick units rather than curing them. There has to be serious attempt on the part of the banks particularly for the SME sector to give them a special treatment before taking the recourse of SARFAESI ACT. Though at various places the state High Courts and Supreme Court has prescribed some guidelines but they are seldom followed. Financial sector reform in India has progressed rapidly on aspects like interest rate deregulation, reduction in reserve requirements, barriers to entry, prudential norms and risk-based supervision but changes required to tackle the NPA problem would have to span the entire gamut of judiciary, polity and the bureaucracy to be truly effective. Unfortunately the policy makers, the politicians and the learned bankers inspite of being aware of the facts are not paying due attention.

It is not that the number of NPA cases should come down but what is more important is that how many NPA accounts are restructured and revived. That will improve the national wealth. We are of the opinion that in most cases the borrowers are unaware about their basic rights and come under the clutches and pressure tactics of the Bank. The borrower usually tries to convince the Banker not to take any immediate stringent action and to lend some time, however does not usually succeed. In turn the Bank instead of offering him the remedies as mentioned in the Reserve Bank of India guidelines, threatens the borrower to make immediate payment or else face the action under the Securitization Act. The bankers are requested to take in account such units and help to revive their situation by referring to a professional consultant. It is further advisable for the Bank to take help of competent consultant as soon as the signs of industrial sickness becomes visible. This will definitely reduce the number of SME’s becoming NPA.

We analyze the enterprising quality of the Promoter, give direction and help to the promoter to find out value additions areas in his business, restructure the marketing set up so as to ensure the working capital cycle. Only the financial paper projections are not enough. Dynamic and innovative mind set of the Consultant will definitely help both the Bank and SME’s in a big way. We refer to the various possibilities, avenues and various provisions for arranging Venture Capital funds for eligible borrowers and identify Strategic Investors too. We are well updated with the concerned Banks policy and its (such as Fair Practice Code for Lenders, SME Charter, Model Debt Collection Policy, Citizens’ Charter etc) ’, Practice & Procedure and Rules & Regulations of the Banks, Guidelines issued by Reserve Bank of India ( pertaining to fair lending policy, interest rate etc); Circulars of the Government of India, District Industries Centers as well as the provisions and interpretation of various statutes such as Law & Practice of Banking, Transfer of Property Act, Companies Act, Indian Contract Act, Specific Relief Act, Law of Torts, Law of Damages and Compensation, SARFAESI Act, DRT Act, Maharashtra State Co-operative Societies Act and Rules, etc and precedents set by past judgments of High Court/Supreme Court/Co-operative courts etc.