Regulations for Non Performing Assets- How effective is the implementation ?

Lending is a major activity for major Banks and lending for capital investments, infrastructure, finances in Government sector and industries, heavy machineries contributes to the development of economy and also providing long term assured interest/fee based income to the Bank. Such corporate loans occupy a significant asset portfolio in many large Banks. The project feasibility, credit risk, cash flows, balance sheet analysis, industry analysis, promoter interests and stakes in the company, credit worthiness are meticulously scrutinized and report created for such large projects as part of loan assessment. Depending on the capital of the Banks and limits assigned by Banks for lending based on different industry norms, Board level approvals are obtained before clearance of such loans. The bifurcation of the limit structure could be a combination of fund based (working capital and term loan) and non -fund based documentary credit /Bank Guarantee as per the applicant request/credit assessment done. In case borrower is involved in exports/imports, there could be foreign currency loan limit and pre-shipment/post shipment credit. Before disbursement of the loan, there are monitoring terms and conditions which are carefully inspected by multiple officers and observations are recorded/documented in the credit note sections.

The performance of these loans are closely monitored and the Central bank in many countries have formulated norms to classify loans as Non -performing when there are defaults in repayments. There could be non-performance contrary to expected norms and possibility of funds diversion by the borrower to associate businesses which requires close monitoring. Across the globe, Basel II, Basel III and Basel IV norms are available for measuring credit risk assessment and capital adequacy ratio calculation based on risk weighed assets. There could also be market risks which potentially could arise in the future- exchange rate risks, industry failures, export/import issues which can also lead to non -performance or default in repayment by the corporate/borrower.

Most of the banks use preprocessing /origination software for corporate credit application analysis, credit scoring and credit decision for large corporates while some of the Banks have manual credit monitoring assessment tools. Post approval, limit booking and account opening will be done as part of lending servicing software. When software is available at branches and which can be accessed centrally by the Central Credit cell of the Bank, all transactions – in terms of disbursements and repayments, are viewed and monitored. There are software provisions available for non -financial conditions check like non-submission of stock statements, non-submission of IT returns periodically during the lending lifecycle to assess the health of the account.

Despite all the checks and computing software, there is human intervention and subjectivity in identifying the loan as Non -performing Asset (NPA). Banks are reluctant to book a loan as NPA considering the huge interest amount which is booked periodically and the associated provisioning which needs to be done impacting the profit and loss of  the Bank.There is also huge reputational impact to the borrower and business of the corporate by identifying loan as NPA. Few of the data provisions in the software are modified and some of the exceptions in the servicing/NPA software are overridden manually to classify the loan as performing. To be precise, Banks adopt conservative approach in classifying corporate loan as NPA when compared to small loans. To reduce the manual intervention to the maximum extent possible and route the activities through systems/software is definitely required.

The Central banks like Reserve Bank of India has requested Banks to periodically submit reports/returns for all large borrowers with various criteria/classifications based on amount sanctioned, amount availed, industry classifications, repayments done etc. to monitor the performance of these accounts remotely. It is possible that some of these data elements are neither captured nor reported accurately resulting in fallacious information being provided to the Reserve al bank. The Reserve bank on its own conducts periodic inspections and brings out the irregularities and reports the same to top management of Banks. The delay in conducting the inspection after the account has gone bad, preparing the report after the inspection, review by authorities and the final communication of report for action reaching the top management of the Bank late may cause the account to deteriorate further or promoter may have made some adjustments in the interim.

Though the guidelines/regulations/policies framed by Reserve Bank for NPA are largely in line with global standards, the measures taken by Bank/Central banks are only partially successful in controlling the mounting NPA 's of public sector Banks in India. The Banks and Borrowers are having relationship beyond the banking norms and principles preventing the proper treatment of NPA as per the guidelines. The top management of the corporate knows the key bank officials/Govt authorities at the highest level which may prevent stricter action against the borrowers. Most of the time, the Banks are able to even circumvent the software to dilute the conditions. When small borrower/farmers with default in loans are treated differently, the large borrowers /corporate enjoy a corporate status.

To conclude, the measures or principles in classifying a loan as bad asset is not followed as per regulations and human intervention prevents the software from automatic classification of the account. There are also numerous provisions for NPA which are added/modified every year by the Central bank of each country and bank officials use this to their advantage- pretending unawareness of the latest guideline, misinterpretation of the clauses, clarification of the circular/guidelines issued by Head Office/Central Bank not responded, clauses on applicability in different industry not explicitly mentioned etc. Though software vendors want to update the NPA module/software based on the new additions/modifications, the interpretation of the guideline provided by different Bank officials makes it difficult to adopt common approach for building the software. The concept of effective early warning for NPA and the implementation measures by Reserve Bank or the Banks are not effective or successful.

The Central Bank of each country or Reserve Bank of India need to examine the practicality of building a software for only NPA and inserting the relevant clauses when changes are done and which can work on top of any core/lending software for better control and monitoring. Banks can share the data periodically or as desired by Reserve Bank in an online manner and integrate with this NPA software run by Central Banks and any exceptions /deviations can only be approved by Central Bank. It does not augur well  to have posto facto rules or modification of the existing norms after incidence has occurred. There could be policies framed for centrally controlling the large corporate accounts through a separate institution with external rolling committee of analysts/consultants (who can be appointed by RBI involving non RBI and non-Bank officials) for periodic scrutiny of such accounts and provide their recommendations from time to time. They can independently monitor and review these accounts whereas the accounting /loan booking, interest application, loan transaction can continue to remain in the original bank. The names of corporates having exposure above certain threshold amount can be made public (by providing in the balance sheet of banks as separate notes or through public accessible portals or through reputed credit agencies) which makes these Corporates obligatory to pay back without defaults and reminding them that they are utilizing public money. Irrespective of the future changes envisaged or to be adopted by the regulator, there should be stricter policies to control the mounting NPAs in public sector banks in India which could potentially erode the entire capital of the Banks at large, paralyzing the economy. The Central bank /Reserve Bank of India cannot silently watch this deterioration as a bystander and evade responsibility. Central bank should frame proactively guidelines and policies by involving leaders of banks, Government officials, industry experts etc. and take responsibility to make these implementable.