Factors affecting Non Performing Assets

A Non Performing Asset (referred to as NPAs henceforth) is an advance where payment of

interest or repayment of installment on principal or both remains unpaid for a period of two quarters
or more and if they have become ‘past due’.

The aim of this segment is to analyse the factors that affect Non Performing Assets and
derive relations to help understand to what degree each factor contributes to an asset becoming non-
performing. Later, a model may be built based on the relations to help predict whether an asset will
become non-performing.

It is to be noted that all of the analysis that will ensue will be with respect to the Indian
banking ecosystem and the dataset used is the official Reserve Bank of India curated database

https://dbie.rbi.org.in/DBIE/dbie.rbi?site=publications#!4

The banks have been divided into the following categories by the RBI:
1. All Commercial Banks
2. State Bank of India and its Associates
3. Nationalized Banks
4. Private Banks

The NPAs held by each bank have been classified by contributing sector as:
1. Priority Sector NPAs
2. Non Priority Sector NPAs
3. Public Sector NPAs

OBJECTIVE

To study the factors that turn assets into non-performing assets.

To understand why the factors affect the performance of assets.
To develop a model that can predict whether an asset will become non-performing

LIMITATIONS

Time gap between the reference literature and the current study is at least 2 years.
The dataset under consideration consists of data from 2005-2017 only.

SCOPE OF STUDY

Relations derived through statistical inferences can be used to create a model that can
predict whether an asset will become non-performing and, potentially, be used to prevent
them from happening.
Help develop policies to reduce the occurrence of NPAs.

METHODOLOGY

The present study aims to analyse the factors affecting NPAs using computer aided
statistical inferences and visualization techniques. The main sources of information are RBI
bulletins and circulars.
TIME PERIOD
The time period of the data is from 2005-2017

The reason for the high amount of NPAs in the banking sector:
Following the economic liberalization of 1991, a multitude of entrepreneurs started setting
up businesses fuelled predominantly by loans from banks. In the face of rising global competition,
many businesses shut down resulting in the loans acquired by them becoming non-performing. In
recent years, wilful default has become more common which has further compounded the issue. (M.
Karunakar, 2008)

Factors affecting NPAs can broadly divided into 2 categories*:

A) Internal Factors
(1) Defective Lending Process
(2) Inappropriate Technology
(3) Poor Credit Analysis
(4) Managerial Deficiencies
(5) Absence of Regular Visit to Customer
(6) Re loaning process

B) External Factors
(1) Irregularity in Recovery
(2) Wilful Defaulter
(3) Natural calamities
(4) Industrial sickness
(5) Government policies
 External Factors

a) Wilful Defaults
Wilful defaulters are individuals, juristic persons and all other forms of business
enterprises, whether incorporated or not that (referred to hence as a ‘unit’) that have
committed a wilful default which is deemed to have occurred if the following conditions
are satisfied:
a. The unit has defaulted in meeting its payment / repayment obligations to the lender
even when it has the capacity to honour the said obligations.
b. The unit has defaulted in meeting its payment / repayment obligations to the lender
and has not utilised the finance from the lender for the specific purposes for which
finance was availed of but has diverted the funds for other purposes.
c. The unit has defaulted in meeting its payment / repayment obligations to the lender
and has siphoned off the funds so that the funds have not been utilised for the
specific purpose for which finance was availed of, nor are the funds available with
the unit in the form of other assets.
d. The unit has defaulted in meeting its payment / repayment obligations to the lender
and has also disposed off or removed the movable fixed assets or immovable
property given for the purpose of securing a term loan without the knowledge of the
bank / lender.
(RBI, 2015)

As on Number of wilful defaulters Amount (in crore rupees)

March 31, 2016 8,315 76,730
March 31, 2017 8,915 92,379
March 31, 2018 9,331 1,22,017
June 30, 2018 9,501 1,28,179
Table of number of wilful defaults recorded by Public Sector Banks per year (Hindu,
2018)

The number of wilful defaulters has been increasing steadily over the last four financial
years with PSBs adding 1,186 more to wilful defaulters’ list in 27 months (March 31,
2016 to June 30, 2018). This has resulted in an increase in the amount of wilful defaults
which has consequently led to loans becoming non-performing. Previously, many
borrowers strategically defaulted on their loans knowing that the legal resources
available to creditors were slow in achieving results. However, with changes in
government policies in recent years with the introduction of legislation such as the
Insolvency and Bankruptcy Code (Affairs, 2016), the situation shows signs of
improvement.

b) Contribution of priority and non-priority sectors to rising NPAs

The RBI classifies the following industries under the priority sector:
(i) Agriculture
(ii) Micro, Small and Medium Enterprises
(iii) Export Credit
(iv) Education
(v) Housing
(vi) Social Infrastructure
(vii) Renewable Energy
(viii) Others (Micro Enterprises, Advances to weaker sections)
(RBI M. C.)
 As per the directives of the RBI, 40 percent of Adjusted Net Bank Credit or Credit
Equivalent Amount of Off-Balance (whichever is higher) is the lending target set for the
priority sector.

Priority Sector Non-Priority Sector Total

Year Gross NPAs as Gross NPAs as Gross NPAs as

Gross Gross Gross
Gross NPAs Per Cent of Gross NPAs Per Cent of Gross NPAs Per Cent of
Advances Advances Advances
Total Total Total
Public Sector Banks

2017 19,599.15 1,542.76 24.1 31,823.09 4,867.80 75.9 51,422.24 6,410.56 100.0

2016 18,737.48 1,281.16 25.5 32,084.08 3,739.52 74.5 50,821.56 5,020.68 100.0

2015 16,859.54 936.85 35.7 31,593.15 1,690.60 64.3 48,452.69 2,627.45 100.0

2014 15,192.98 791.92 36.5 30,711.60 1,375.47 63.5 45,904.58 2,167.39 100.0

2013 12,790.00 669.00 42.9 27,769.00 890.00 57.1 40,559.00 1,559.00 100.0

Table: Share of Sectors in NPAs (Source : RBI)

80.0

70.0

60.0

50.0

40.0 Priority Sector

Non-Priority Sector
30.0

20.0

10.0

0.0
2013 2014 2015 2016 2017
Chart : Share of priority and non-priority sectors in Gross NPAs

The share of the Priority Sector in NPAs has been falling over the past few years, while the share
of non-priority sector has been increasing. However, in absolute terms, the amount of NPAs held
by the sector has been constantly increasing. Also, from the table, it can be noticed that the rate
at which NPAs change relative to the increase in gross advances is much higher in the cases of
the non- priority sector than in the case of the priority sector.
This relative good performance of the priority sector can be attributed to policy reforms imposed
by the government in the priority sector. However, negligence with respect to the non-priority
sector whether by the banks due to internal mismanagement or due to weak government policies
has resulted in a burgeoning net NPA as with respect to change in gross advances.

c) Repo Rate

A repo is a money market instrument used to enable collateralised short term borrowing and
lending through the sale/purchase operations in debt instruments. A repo rate is an annualised
interest rate for the funds transferred by a lender to a borrower.
Central banks use the repo to inject/withdraw liquidity into/from the market and to reduce
volatility in short term, particularly in call money rates which can lead to the easing/tightening of
monetary conditions.
In this section, we attempt to see the relation between repo rates set by the Reserve Bank of
India on the gross NPAs (as a percentage of advances) of the State Bank of India (SBI).
 The SBI* was chosen as, being one of India’s major nationalised banks, generally follows every
RBI circular to the letter.
*SBI and associate banks considered in the dataset

Year Repo Rate NPA % (SBI*) NPA% (All

Scheduled Banks
2008 7.75 2.58 1.92
2009 4.75 2.56 2.31
2010 4.75 2.82 2.51
2011 6.75 3.12 2.35
2012 8.5 4.36 2.95
2013 7.75 4.42 3.23
2014 8 4.96 3.83
2015 7.5 4.28 4.27
2016 6.75 6.38 7.48
2017 6.25 9.11 9.32
Table: Repo Rates and NPA as a percentage of gross advances of SBI* and all scheduled banks
(Source: RBI)

10

7
NPA% of SBI*
6
Repo Rate
5

4 NPA % of All Scheduled

Banks
3

0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Chart: Comparison between repo rates and NPA% of SBI and related banks

At first glance, there seems to be no relation between the repo rates and the NPAs as a percentage of
gross advances. However, when normalised,
 3

0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Normalized NPA %
-1
Normalized Repo

-2

-3

-4

-5

This indicates a strong relation between the two variables. Indeed, when the repo rate increases,
the banks would also raise their interest rates making it difficult for borrowers to pay back the
money and defaulting on the loan resulting in rising NPAs.

Conclusion
This report has covered a few factors affecting NPAs and noted down the reasons for why the
factors have resulted in rising NPAs in recent years.. The trend seems to indicate that NPAs will
continue to rise well into the future and efforts must be made by the government and banks to
reduce the NPAs so as to ensure continued stability of the financial system.

Works Cited
Affairs, M. o. (2016, May 28). Retrieved from Ministry of Corporate Affairs:
http://mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf

Hindu, T. (2018, August 2). Buisness Insider. Retrieved from The Hindu Buisness Insider:
https://www.thehindubusinessline.com/money-and-banking/rising-bad-debts-psbs-add-1186-more-
to-wilful-defaulters-list-in-27-months/article24584829.ece

M. Karunakar, M. K. (2008). Are non - Performing Assets Gloomy or Greedy from Indian
Perspective? Research Journal of Social Sciences , 6.

RBI, M. C. (n.d.). MASTER CIRCULAR- PRIORITY SECTOR LENDING-TARGETS AND

CLASIFICATION . Retrieved from http://www.iibf.org.in/documents/priority-sector-lending.pdf

RBI, M. C. (2015, July 1). rbi.org. Retrieved from

https://rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9907#21