A REPORT ON

NON-PERFORMING ASSETS-

CHALLENGE TO THE PUBLIC SECTOR BANKS

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INTRODUCTION

After liberalization the Indian banking sector developed very appreciate. The RBI
also nationalized good amount of commercial banks for proving socio economic
services to the people of the nation. The Public Sector Banks have shown very good
performance as far as the financial operations are concerned. If we look to the
glance of the financial operations, we may find that deposits of public to the Public
Sector Banks have increased from 859,461.95crore to 1,079,393.81crore in 2003,
the investments of the Public Sector Banks have increased from 349,107.81crore to
545,509.00crore, and however the advances have also been increased to
549,351.16crore from 414,989.36crore in 2003. The total income of the public
sector banks have also shown good performance since the last few years and
currently it is 128,464.40crore. The Public Sector Banks have also shown
comparatively good result. The gross profits of the Public Sector Banks currently
29,715.26crore which has been doubled to the last to last year, and the net profit of
the Public Sector Banks is 12,295,47crore. However, the only problem of the Public
Sector Banks these days are the increasing level of the non performing assets. The
non performing assets of the Public Sector Banks have been increasing regularly
year by year. If we glance on the numbers of non performing assets we may come
to know that in the year 1997 the NPAs were 47,300crore and reached to
80,246crore in 2002. The only problem that hampers the possible financial
performance of the Public Sector Banks is the increasing results of the non
performing assets. The non performing assets impacts drastically to the working of
the banks.

The efficiency of a bank is not always reflected only by the size of its balance sheet
but by the level of return on its assets. NPAs do not generate interest income for the
banks, but at the same time banks are required to make provisions for such NPAs
from their current profits.

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NPAs have a deleterious effect on the return on assets in several ways –

They erode current profits through provisioning requirements

They result in reduced interest income

They require higher provisioning requirements affecting profits and accretion to

capital funds and capacity to increase good quality risk assets in future, and

They limit recycling of funds, set in asset-liability mismatches, etc. The RBI has
also tried to develop many schemes and tools to reduce the non performing assets
by introducing internal checks and control scheme, relationship managers as stated
by RBI who have complete knowledge of the borrowers, credit rating system, and
early warning system and so on. The RBI has also tried to improve the securitization
Act and SRFAESI Act and other acts related to the pattern of the borrowings. Though
RBI has taken number of measures to reduce the level of the non performing assets
the results is not up to the expectations. To improve NPAs each bank should be
motivated to introduce their own precautionary steps. Before lending the banks
must evaluate the feasible financial and operational prospective results of the
borrowing companies. They must evaluate the business of borrowing companies by
keeping in considerations the overall impacts of all the factors that influence the
business

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RESEARCH OPERATION

1. Significance of the study

The main aim of any person is the utilization money in the best manner since the
India is country were more than half of the population has problem of running the
family in the most efficient manner. However Indian people faced large number of
problem till the development of the full-fledged banking sector. The Indian banking
sector came into the developing nature mostly after the 1991 government policy.
The banking sector has really helped the Indian people to utilise the single money in
the best manner as they want. People now have started investing their money in
the banks and banks also provide good returns on the deposited amount. The
people now have at the most understood that banks provide them good security to
their deposits and so excess amounts are invested in the banks. Thus, banks have
helped the people to achieve their socio economic objectives. The banks not only
accept the deposits of the people but also provide them credit facility for their
development. Indian banking sector has the nation in developing the business and
service sectors. But recently the banks are facing the problem of credit risk. It is
found that many general people and business people borrow from the banks but
due to some genuine or other reasons are not able to repay back the amount drawn
to the banks. The amount which is not given back to the banks is known as the non
performing assets. Many banks are facing the problem of non performing assets
which hampers the business of the banks. Due to NPAs the income of the banks is
reduced and the banks have to make the large number of the provisions that would
curtail the profit of the banks and due to that the financial performance of the banks
would not show good results The main aim behind making this report is to know
how Public Sector Banks are operating their business and how NPAs play its role to
the operations of the Public Sector Banks. The report NPAs are classified according
to the sector, industry, and state wise. The present study also focuses on the
existing system in India to solve the problem of NPAs and comparative analysis to
understand which bank is playing what role with concerned to NPAs.Thus, the study
would help the decision makers to understand the financial performance and growth
of Public Sector Banks as compared to the NPAs

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2. Objective of the study

Primary objective:

The primary objective of the making report is:

To know why NPAs are the great challenge to the Public Sector Banks

Secondary objectives:

The secondary objectives of preparing this report are:

To understand what is Non Performing Assets and what are the underlying reasons
for the emergence of the NPAs.

To understand the impacts of NPAs on the operations of the Public Sector Banks.

To know what steps are being taken by the Indian banking sector to reduce the
NPAs?

To evaluate the comparative ratios of the Public Sector Banks with concerned to the
NPAs.

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2. Research methodology

The research methodology means the way in which we would complete our
prospected task. Before undertaking any task it becomes very essential for any one
to determine the problem of study. I have adopted the following procedure in
completing my report study.

1. Formulating the problem

2. Research design

3. Determining the data sources

4. Analysing the data

5. Interpretation

6. Preparing research report

(1) Formulating the problem

I am interested in the banking sector and I want to make my future in the banking
sector so decided to make my research study on the banking sector. I analysed first
the factors that are important for the banking sector and I came to know that
providing credit facility to the borrower is one of the important factors as far as the
banking sector is concerned. On the basis of the analysed factor, I felt that the
important issue right now as far as the credit facilities are provided by bank is non
performing assets. I started knowing about the basics of the NPAs and decided to
study on the NPAs. So, I chose the topic

“Non Performing Assts the great challenge before the Public Sector Banks”.

(2) Research Design

The research design tells about the mode with which the entire project is prepared.
My research design for this study is basically analytical. Because I have utilised the
large number of data of the Public Sector Banks.

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(3) Determining the data source

The data source can be primary or secondary. The primary data are those data
which are used for the first time in the study. However such data take place much
time and are also expensive. Whereas the secondary data are those data which are
already available in the market. These data are easy to search and are not
expensive too.for my study I have utilised totally the secondary data.

(4) Analysing the data

The primary data would not be useful until and unless they are well edited and
tabulated. When the person receives the primary data many unuseful data would
also be there. So, I analysed the data and edited them and turned them in the
useful tabulations. So, that can become useful in my report study. (5)
Interpretation of the data

With use of analysed data I managed to prepare my project report. But the
analyzing of data would not help the study to reach towards its objectives. The
interpretation of the data is required so that the others can understand the crux of
the study in more simple way without any problem so I have added the chepter of
analysis that would explain others to understand my study in simpler way.

(6) Project writing

This is the last step in preparing the project report. The objective of the report
writing was to report the findings of the study to the concerned authorities.

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4. Limitations of the study

The limitations that I felt in my study are:

It was critical for me to gather the financial data of the every bank of the Public
Sector Banks so the better evaluations of the performance of the banks are not
possible.

 Since my study is based on the secondary data, the practical operations as

related to the NPAs are adopted by the banks are not learned.

 Since the Indian banking sector is so wide so it was not possible for me to cover
all the banks of the Indian banking sector.

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INDIAN BANKING SECTOR

Banking in India has its origin as early as the Vedic period. It is believed that the
transition from money lending to banking must have occurred even before Manu,
the great Hindu Jurist, who has devoted a section of his work to deposits and
advances and laid down rules relating to rates of interest. During the Mogul period,
the indigenous bankers played a very important role in lending money and financing
foreign trade and commerce. During the days of the East India Company, it was the
turn of the agency houses to carry on the banking business. The General Bank of
India was the first Joint Stock Bank to be established in the year 1786. The others
which followed were the Bank of Hindustan and the Bengal Bank. The Bank of
Hindustan is reported to have continued till 1906 while the other two failed in the
meantime. In the first half of the 19th century the East India Company established
three banks; the Bank of Bengal in 1809, the Bank of Bombay in 1840 and the Bank
of Madras in 1843. These three banks also known as Presidency Banks were
independent units and functioned well. These three banks were amalgamated in
1920 and a new bank, the Imperial Bank of India was established on 27th January
1921. With the passing of the State Bank of India Act in 1955 the undertaking of the
Imperial Bank of India was taken over by the newly constituted State Bank of India.
The Reserve Bank which is the Central Bank was created in 1935 by passing
Reserve Bank of India Act 1934. In the wake of the Swadeshi Movement, a number
of banks with Indian management were established in the country namely, Punjab
National Bank Ltd, Bank of India Ltd, Canara Bank Ltd, Indian Bank Ltd, the Bank of
Baroda Ltd, the Central Bank of India Ltd. On July 19, 1969, 14 major banks of the
country were nationalised and in 15th April 1980 six more commercial private
sector banks were also taken over by the government.

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Indian Banking: A Paradigm shift-A regulatory point of view

The decade gone by witnessed a wide range of financial sector reforms, with many
of them still in the process of implementation. Some of the recently initiated
measures by the RBI for risk management systems, anti money laundering
safeguards and corporate governance in banks, and regulatory framework for non
bank financial companies, urban cooperative banks, government debt market and
forex clearing and payment systems are aimed at streamlining the functioning of
these instrumentalities besides cleansing the aberrations in these areas. Further,
one or two all India development financial institutions have already commenced the
process of migration towards universal banking set up. The banking sector has to
respond to these changes, consolidate and realign their business strategies and
reach out for technology support to survive emerging competition. Perhaps taking
note of these changes in domestic as well as international arena All of we will agree
that regulatory framework for banks was one area which has seen a sea-change
after the financial sector reforms and economic liberalisation and globalisation
measures were introduced in 1992-93. These reforms followed broadly the
approaches suggested by the two Expert Committees both set up under the
chairmanship of Shri M. Narasimham in 1991 and 1998, the recommendations of
which are by now well known. The underlying theme of both the Committees was to
enhance the competitive efficiency and operational flexibility of our banks which
would enable them to meet the global competition as well as respond in a better
way to the regulatory and supervisory demand arising out of such liberalisation of
the financial sector. Most of the recommendations made by the two Expert
Committees which continued to be subject matter of close monitoring by the
Government of India as well as RBI have been implemented. Government of India
and RBI have taken several steps to :-

(a) Strengthen the banking sector,

(b) Provide more operational flexibility to banks,

(c) Enhance the competitive efficiency of banks, and

(d) Strengthen the legal framework governing operations of banks.

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Regulatory measures taken to strengthen the Indian Banking sectors

The important measures taken to strengthen the banking sector are briefly, the
following:

• Introduction of capital adequacy standards on the lines of the Basel norms,

• prudential norms on asset classification, income recognition and provisioning,

• Introduction of valuation norms and capital for market risk for investments

• Enhancing transparency and disclosure requirements for published accounts ,

• Aligning exposure norms – single borrower and group-borrower ceiling – with inter-
national best practices

• Introduction of off-site monitoring system and strengthening of the supervisory

framework for banks. (A) Some of the important measures introduced to provide
more operational flexibility to banks are:

• Besides deregulation of interest rate, the boards of banks have been given the
authority to fix their prime lending rates. Banks also have the freedom to offer
variable rates of interest on deposits, keeping in view their overall cost of funds.

• Statutory reserve requirements have significantly been brought down.

• The quantitative firm-specific and industry-specific credit controls were abolished

and banks were given the freedom to deploy credit, based on their commercial
judgment, as per the policy approved by their Boards.

• The banks were given the freedom to recruit specialist staff as per their
requirements,

• The degree of autonomy to the Board of Directors of banks was substantially

enhanced.

• Banks were given autonomy in the areas of business strategy such as, opening of
branches / administrative offices, introduction of new products and certain other
operational areas. (b) Some of the important measures taken to increase the

competitive efficiency of banks are the following:

• Opening up the banking sector for the private sector participation.

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• Scaling down the shareholding of the Government of India in nationalised banks
and of the Reserve Bank of India in State Bank of India. (c) Measures taken by the
Government of India to provide a more conducive legal environment for recovery of
dues of banks and financial institutions are:

• Setting up of Debt Recovery Tribunals providing a mechanism for expeditious loan

recoveries.

• Constitution of a High Power Committee under former Justice Shri Eradi to suggest
appropriate foreclosure laws.

• An appropriate legal framework for securitisation of assets is engaging the

attention of the Government, Due to this paradigm shift in theregulatory framework
for banks had achieved the desired results. The banking sector has shown
considerable degree of resilience. (a) The level of capital adequacy of the Indian
banks has improved: the CRAR of public sector banks increased from an average of
9.46% as on March 31, 1995 to 11.18% as on March 31, 2001. (b) The public sector
banks have also made significant progress in enhancing their asset quality,
enhancing their provisioning levels and improving their profits.

• The gross and net NPAs of public sector banks declined sharply from 23.2% and
14.5% in 1992-93 to 12.40% and 6.7% respectively, in 2000-01.

• Similarly, in regard to profitability, while 8 banks in the public sector recorded

operating and net losses in 1992-93, all the 27 banks in the public sector showed
operating profits and only two banks posted net losses for the year ended March 31,
2001.

• The operating profit of the public sector banks increased from Rs.5628 crore as on
March 31, 1995 to Rs.13,793 crore as on March 31, 2001.

• The net profit of public sector banks increased from Rs.1116 crore to Rs.4317
crore during the same period, despite tightening of prudential norms on provisioning
against loan losses and investment valuation. The accounting treatment for
impaired assets is now closer to the international best practices and the final
accounts of banks are transparent and more amenable to meaningful interpretation
of their performance.

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WAY FORWARD

RBI president recently recommended Indian banks to go for larger provisioning

when the profits are good without frittering them away by way of dividends,
however tempting it may be. As a method of compulsion, RBI has recently advised
banks to create an Investment Fluctuation Reserve upto 5 per cent of the
investment portfolio to protect the banks from varying interest rate regime. He
further added that one of the means for improving financial soundness of a bank is
by enhancing the provisioning standards of the bank. The cumulative provisions
against loan losses of public sector banks amounted to a mere 41.67% of their gross
NPAs for the year ended March 31, 2001. The amount of provisions held by public
sector banks is not only low by international standards but there has been wide
variation in maintaining the provision among banks. Some of the banks in the public
sector had as low provisioning against loan losses as 30% of their gross NPAs and
only 5 banks had provisions in excess of 50% of their gross NPAs. This is inadequate
considering that some of the countries maintain provisioning against impaired
assets at as high as 140%. Indian Banks should improve the provisioning levels to at
least 50% of their gross NPAs. There should therefore be an attitudinal change in
banks’ policy as regards appropriation of profits and full provisioning towards
already impaired assets should become a priority corporate goal. He also
suggested that banks should also develop a concept of building desirable capital
over and abovethe minimum CRARwhich is insisted upon in developed regulatory
regimes like UK. This can be at, say around 12 percent as practised even today by
some of the Indian banks, so as to provide well needed cushion for growth in risk
weighted assets as well as provide for unexpected erosion in asset values. As
banks would have observed, the changes in the regulatory framework are now
brought in by RBI only through an extensive consultative process with banks as well
as public wherever warranted. While this serves the purpose of impact assessment
on the proposed measures it also puts the banks on notice to initiate appropriate
internal readjustment to meet the emerging regulatory prescriptions. Though
adequate transitional route has been provided for switchover to new regulatory
measures such as scaling down the exposure to capital market, tightening the
prudential requirements like switch over to 90 day NPA norm, reduction in exposure
norms, etc., I observe from the various quarters

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from which RBI gets its inputs that the banks are yet to take serious steps towards
implementation of these measures. The Boards of banks have been accorded
considerable autonomy in regard to their corporate strategy as also several other
operational matters. This does not; however, seem to have translated to any
substantial improvement in customer service. It needs to be recognised that
meeting the requirements of the customer – whether big or small – efficiently and in
a costeffective manner, alone will enable the banks to withstand the global
competition as also the competition from non-bank institutions. The profitability of
the public sector banks is coming under strain. Despite the resilience shown by our
banks in the recent times, the income from recapitalisation bonds accounted for a
significant portion of the net profits for some of the nationalised banks. The Return
on Assets (RoA) of public sector banks has, on an average, declined from 0.54 for
the year ended March 31, 1999 to 0.43 for the year ended March 31, 2001.
Therefore, the Boards’ attention needs to be focused on improving the profitability
of the bank. The interest income of public sector banks as a percentage of total
assets has shown a declining trend since 1996-97: it declined from 9.69 in 1996-97
to 8.84 in 2000-01. Similarly, the spread (net interest income) as a percentage of
total assets also declined from 3.16 in 1996-97 to 2.84 in 2000-01. A disheartening
feature is that a large number of public sector banks have recorded far below the
median RoA of 0.4% for 2000-01 in their peer group. Incidentally the RoA recorded
by new private banks and foreign banks ranged from 0.8% to 1% for the same
period. An often quoted reason for the decline in profitability of public sector banks
is the stock of NPAs which has become a drag on the bank’s profitability. As you are
aware, the stock of NPAs does not add to the income of the bank while at the same
time, additional cost is incurred for keeping them on the books. To help the public
sector banks in clearing the old stock of chronic NPAs, RBI had announced ‘one-time
non discretionary and non discriminatory compromise settlement schemes’ in 2000
and 2001. Though many banks tried to settle the old NPAs through this transparent
route, the response was not to the extent anticipated as the banks had been
bogged down by the usual fear psychosis of being averse to settling dues where
security was available. The moot point is if the underlying security was not realised
over decades in many cases due to extensive delay in litigation process, should not
the banks have taken advantage of the one time opportunity provided under RBI
scheme to cleanse their books of chronic

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15
NPAs? This would have helped in realizing the carrying costs on such non-income
earning NPAs and released the funds for recycling. If better steps are taken placed
in this connection then the performance of the Public Sector Banks can show very
good and healthy results in the shorter period. To make the better future of the
Public Sector Banks, the Boards need to be alive to the declining profitability of the
banks. One of the reasons for the low level of profitability of public sector banks is
the high operating cost. The cost income ratio (which is also known as efficiency
ratio of public sector banks) increased from 65.3 percent for the year ended March
31, 2000 to 68.7 per cent for the year ending March 31, 2001. The staff expenses as
a proportion to total income formed as high as 20.7% for public sector banks as
against 3.3% for new banks and 8.2% for foreign banks for the year ended March
31, 2001. There is thus an imperative need for the banks to go for cost cutting
exercise and rationalise the expenses to achieve better efficiency levels in operation
to withstand declining interest rate regime. Boards of banks have much more
freedom now than they had a decade ago, and obviously they have to play the role
of change agents. They should have the expertise to identify, measure and monitor
the risks facing the bank and be capable to direct and supervise the bank’s
operations and in particular, its exposures to various sectors of the economy, and
monitoring / review thereof, pricing strategies, mitigation of risks, etc. The Board of
the banks should also ensure compliance with the regulatory framework, and ensure
adoption of the best practices in regard to risk management and corporate
governance standards. The emphasis in the second generation of reforms ought to
be in the areas of risk management and enhancing of the corporate governance
standards in banks.

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17
THE INDIAN BANKING INDUSTRY

The origin of the Indian banking industry may be traced to the establishment of the
Bank of Bengal in Calcutta (now Kolkata) in 1786. Since then, the industry has
witnessed substantial growth and radical changes. As of March 2002, the Indian
banking industry consisted of 97 Commercial Banks, 196 Regional Rural Banks, 52
Scheduled Urban Co-operative Banks, and 16 Scheduled State Co-operative Banks.
The growth of the banking industry in India may be studied in terms of two broad
phases: Pre Independence (1786-1947), and Post Independence (1947 till date). The
post independence phase may be further divided into three sub-phases:

• Pre-Nationalisation Period (1947-1969)

• Post-Nationalisation Period (1969-1991)

• Post-Liberalisation Period (1991- till date) The two watershed events in the
postindependence phase are the nationalisation of banks (1969) and the initiation
of the economic reforms (1991). This section focuses on the evolution of the
banking industry in India post-liberalisation.

1. Banking Sector Reforms - Post-Liberalisation

In 1991, the Government of India (Gol) set up a committee under the

chairmanship of Mr. Narasimaham to make an assessment of the banking sector.
The report of this committee contained recommendations that formed the basis of
the reforms initiated in 1991. The banking sector reforms had the following
objectives: 1. Improving the macroeconomic policy framework within which banks
operate; 2. Introducing prudential norms; 3. Improving the financial health and
competitive position of banks; 4. Building the financial infrastructure relating to
supervision, audit technology and legal framework; and 5. Improving the level of
managerial competence and quality of human resources.

1.1 Impact of Reforms on Indian Banking Industry

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