The most recent NPA crisis experienced by India’s banks started in 2014-15. This NPA crisis mostly concentrated within PSU banks. The gross NPA ratio reached a peak of 11.2% (14.6% for PSUs) in 2017-18, against a normal expectation for gross NPA at 3%. Highest GNPAs were reported by Central Bank of India at 18%, Indian Overseas Bank (20.4%) and UCO Bank (20.%), with the total commercial bank NPA figure hitting a peak of Rs. 9.34 lakh crores (USD 133 Billion) in March 2019. Meanwhile, neighboring countries like Indonesia and Vietnam, with similar economic situations, reported much lower NPA rates of 2.8% and 2.1%, during this time respectively, as per World Bank data¹. According to the Reserve Bank of India’s Trends and Progress of Banking in India 2018 report², India’s recovery rate of NPAs in 2018 stood at a mere 14.9%. This underscores the considerable burden that NPAs pose on India’s banking sector, positioning it among the weakest in the world.
While there can be many factors responsible for high NPAs in PSUs, this episode was largely a result of weak due-diligence, poor operational monitoring of loans, repeated evergreening of bad loans, and weak banking regulations.
Assuming an NPA rate of 5%, a recovery rate of 20% and the loan term of 5 years, 1% additional NPA results in a realized loss of 17 bps each year. The Net Interest Income Margin for a typical commercial bank stands at 2.75%. So, an additional 5% NPA will reduce the bank’s income by 30% besides significantly damaging its financial solvency.
In response to the NPA crisis, the Indian government, with assistance from RBI, revamped many regulations, especially the Insolvency and Bankruptcy Code, SARFAESI Act and RDDBFI. RBI also enhanced vigilance and enforcement of its regulations. RBI’s strict monitoring is evident from the increasing number of penalties enforced on commercial banks for violations of NPA guidelines, particularly for shortfall in assessment of NPA or delay in NPA recognition. In this article we shed light on the various scenarios and situations within commercial banks that can attract scrutiny from RBI.
Timing of Classification
Time is one important factor in classifying and provisioning NPAs. Identification of NPAs should be done on a daily ongoing basis. A loan becomes an NPA upon failure to provide income, this includes:
- For a term loan, interest and/or principal installments are overdue for more than 90 days. ( it includes all kinds of home loans, working capital loans, personal loans, gold loans, vehicle loans, property loans and so on which have a principal and interest)
- For Overdraft/Cash Credit (OD/CC), the account is ‘out of order.’
- Bills purchased and discounted remain overdue for over 90 days.
- For short-duration crops, principal or interest installments are overdue for two crop seasons.
- For long-duration crops, principal or interest installments are overdue for one crop season.
- The liquidity facility remains outstanding for over 90 days in securitization transactions.
- In derivative transactions, unpaid positive mark-to-market values overdue for 90 days from the specified payment date are classified as NPAs.
Classification as an NPA must be immediate, the bank must not wait till the end of the quarter or financial year to classify an asset from standard to sub-standard (NPA) since the bank is continually accruing income from the asset, while in reality, the cash income has supposedly stopped. A delay in the classification of a standard asset as NPA will affect the profit calculation of the bank.
Divergence in Income Recognition and Asset Classification (IRAC)
Banks must identify accounts that are likely to face distress and potentially become NPAs soon. Such borrower accounts should also be notified at the end of the day if they are overdue. They are categorized as SMAs (Special Mention Accounts) and the banks should be extra diligent about them. It is one of the most important steps in NPA management.
Restructuring and provisioning must be done based on asset classification. As soon as a standard asset is reclassified as a sub-standard asset, income recognition will be done on a cash basis rather than an accrual basis. Provisioning for bad loans can also become very complicated. Sometimes, provisioning amounts assessed and reported by Banks may differ from the one calculated during onsite RBI inspection. In addition, if there is any delay in calculating these figures, the NPA figure will be different. The Risk Assessment Report(RAR) prepared by RBI for each bank reveals these divergences and will certainly draw a penalty.
The best and most effective solution is to have a robust computing system, good enough to handle granular data daily. Annuity Risk’s NPA vigilance system needs very little human intervention and it integrates with bank’s core IRAC software to ensure that income adjustment is done accurately and promptly whenever the (re) classification of any asset changes (eg. from sub-standard to loss) and vice versa.
According to the latest Financial Stability Report published by RBI in Dec 2023, the GNPA level is at 3.2% – the lowest in 10 years (at INR 5.71 crores, USD 70 Billion), also coinciding with a healthy profitability (Net Interest Income) level. This is all the more reason to celebrate and commit towards upholding and advancing the best practices in monitoring bank advances. A comprehensive monitoring software forms the backbone of this strength and superiority.
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Copyright © 2023 Annuity Risk India Pvt. Ltd.