Private banks rein in NPAs, PSBs continue to bleed

By PK Dey

Non-performing assets, an indicator of the banking industry's health, have risen more in
public sector banks (PSBs) compared with the private lenders during April-June quarter,
according to an FE study. The net non-performing assets (NNPA ) of 14 private banks
decreased by 23.5% during the period as against a rise of 43.8% for 25 PSBs.

Milind Gadkari, GM, CARE Ratings, said, "Private sector banks had traditionally focused on
high return, short-medium term, unsecured retail lending products, personal loans and credit
cards. Therefore, they faced relatively higher NPAs as compared to PSBs. However, post
September 2008, private banks contracted their retail lending and stepped up their recovery
processes, thereby controlling increase in NPA levels. PSBs, on the other hand, reported
higher slippages especially from the restructured assets leading to an increase in GNPAs/
NNPAs in the recent quarters."

Gross non-performing assets (GNPA) of private banks increased 7.4% as against 37.2% of
PSBs. Among the PSBs, Indian Bank registered highest rise in GNPA, followed by Bank of
India.

The average NNPAs to net advances ratio of 25 PSBs rose to 1.05% in April-June 2010 from
0.89% in the year-ago period. In private banks, the ratio decreased from 1.30% to 0.80%
during the period.

In absolute terms, NNPA of 14 private banks dipped from Rs 7,244 crore in April-June 2009
to Rs 5,538 crore in April-June 2010. Among the private banks, Jammu & Kashmir Bank
reported the maximum drop in NNPA, followed by YES Bank (YESBANK.NS : 354.05
+2.65 ). YES Bank's key strength has been its ability to maintain a healthy asset quality,
despite the strong balance sheet growth in past years. During Q1FY11, GNPA of the bank
declined 2.8% year-on-year and NNPA fell 63.5%.

For PSBs, NNPA increased from Rs 13,926 crore to Rs 20,026 crore. Indian Bank, Punjab
National Bank and State Bank of Travancore registered the maximum NNPA among the
nationalised banks. State Bank of India (SBIN.NS : 3265 +17.6 ), however, has not declared
the sticky loans figures so far.

Among private banks, NNPA of ICICI Bank (ICICIBANK.NS : 1132.6 +6.4 ) decreased
from Rs 4,608 crore to Rs 3,456 crore during the period. Net non-performing assets to net
advances ratio of ICICI Bank from 2.33% in the corresponding quarter last fiscal to 1.87% in
April-June 2010 and in ING Vysya Bank, it rose from 1.27 % to 1.36%. Top three private
banks according to the ratio of NNPAs to advances are DCB, ICICI Bank and ING Vysya
Bank.

Among the PSBs, PNB increased its NNPAs to net advances ratio from 0.19% to 0.66% and
Indian Bank from 0.19% to 0.76%. The top three PSBs according to the ratio of NNPAs to
advances are Indian Overseas Bank (IOB.NS : 150.95 +1.25 ), Bank of Maharashtra and
Dena Bank.
The highest increase in NNPA during April-June 2010 was reported by Federal Bank among
private banks and Indian Bank among the PSBs.

Source: Indian Express Finance

Are Non Performing Assets Gloomy from Indian Perspective

By : Arpita on 14 February 2010

Introduction When a borrower, who is under a liability to pay to secured creditors, makes any
default in repayment of secured debt or any installment thereof, the account of borrower is
classified as nonperforming assets (NPA) .NPAs cannot be used for any productive purposes because
they reflect the application of scarce capital and credit funds. Continued growth in NPA threatens
the repayment capacity of the banks and erodes the confidence reposed by them in the banks. In
fact high level of NPAs has an adverse impact on the financial strength of the banks who in the
present era of globalisation, are required to conform to stringent International Standards. “Non
Performing Asset” means an asset or account of a borrower, which has been classified by bank or
financial institution as substandard, doubtful or loan asset . After nationalisation and globalisation
the initial directive that banks were given was to expand their branch network, increase the saving
rate and extent credits to rural, urban and the most important SSI sectors . No doubt this mandate
has been achieved admirably under the regulation of economic reforms initiated in 1991 by the then
Finance Minister and present Prime minister Dr. Manmohan Singh. No doubt it would have been
incomplete without the overhaul of Indian Banking System. Then all of a sudden focus shifted
towards improving quality of assets and better risk management. The Narasimhan committee
reports (First report) recommendations are the basis for initiation of the process, which is still
continuing. The committee has recommended the enactment of a new legislation for securitisation
and empowering banks and financial institution to take possession of the securities and do sell them
without the intervention of the court. The Narasimham Committee Report is without doubt a major
path- breaking piece of work and deserves the support of all who yearn for a more rational and
effective banking system in this country. In order to have the proper understanding of NPA menace,
it is important to have a brief idea of growth and structural changes that have taken place in the
banking sector. The growth of the banking system can be assessed in five phases:- 1) Preliminary
Phase(series of birth and death of banks) 2) Business Phase(period between 1949- 19 69) 3)
Branching Out Phase(period when commercial banks got nationalised) 4) Consolidated
phase(weaknesses and defects were identified) 5) Reforms and Strengthening Phase(1991 to till
date) Indian Banking Industry Saddled with High NPAs: Reasons The liberalization policies launched
in 1991 opened the doors to the entrepreneurs to setup industries and business, which are largely
financed by loans from the Indian banking systems. Business firms and companies fail to pay the
principal amount as well as the interest amount (Bad Loan) . In the global economy prevailing today,
the vulnerability of Indian businesses has increased. A culture change is crept in where repayment of
bank loans is no longer assured. A constant follow up action and vigil are to be exercised by the
operating staff. Diversion of funds and willful default has become more common. As per a study
published in the RBI bulletin in July 1999, diversion of funds and willful default are found to be the
major contributing factors for NPAs in public and private sector banks. Today, the situation looks
optimistic with the industry succeeding in overcoming the hurdles faced earlier. The timely
restructuring and rehabilitation measures have helped to overcome setbacks and hiccups without
seriously jeopardizing their future. The greater transparency and stricter corporate governance
methods have significantly raise the credibility of the corporate sector. The attrition rate in
corporate sector has come down. The challenges before the banks in India today are the raising
NPAs in the retail sector, propelled by high consumerism and lowering of moral standards. Other
Factors: The problem that India faces is not lack of prudential norms but the legal impediments and
time consuming nature of asset disposal process , ‘postponement’ of the problem in order to report
high earnings and to some extent manipulation of by the debtor using political influence. Most of
the banks in India are into this malpractices and fraudulent acts. In the process of earning high
returns on their investment by the above stated method, the banks become bankrupt or penniless. A
vicious effect of the slow legal process is that banks are shying away from risks by investing a greater
than required proportion of their assets in the form of sovereign debt paper. The worst part is that
the NPA of a private enterprise is both financially and politically undesirable. Earlier bankruptcy Law
favored borrowers and law courts were not reliable vehicles. But the circumstances have changed.
Laws were passed allowing the creation of asset management companies, foreign equity
participation in securitisation and asset backed securitization. Impact of NPAs on Banking
Operations: The efficiency of a bank is not reflected only by the size of its balance sheet but also the
level of return on its assets. The NPAs do not generate interest income for banks but at the same
time banks are required to provide provisions for NPAs from their current profits. The NPAs have
deliterious impact in the interest income on the bank, bank profitability because of the providing of
the doubtful debts, return on investment of course. NPAs also disturb the Capital Adequacy Ratio
(CAV) and economic value addition (EVR) of the banks. It is due to above factors, the public sector
banks are faced with bulging NPAs which results in lower income and higher provisioning for
doubtful debts and it will make a dent in their profit margin. In this context of crippling effect on
banks operation the slew asset quality is placed as one of the most important parameters in the
measurement of banks performance under the Camel’s supervisory rating system of RBI. Whether
trading of NPA between Banks illegal or not: The word ‘trading’ here means purchasing or selling of
NPAs between banks. So assignment or trading falls under the guidelines of Banking Regulation Act
(BRA) which makes it legal . But the Gujarat High court has recently held that the buying and selling
of non performing assets is illegal. The court has ruled that such an activity is not a part of “banking
activity” as contemplated under the Banking Regulation Act, 1949. The court held that “Interse
transfer of NPAs by banks is illegal and not a part of banking activity under the BR Act. Trading in
debts is a speculative form of transaction that is not permissible activity and thus, cannot be a part
of the business of a banking system” The ruling had an impact of sending shockwaves through the
backbone of Indian economy and came under the greater scrutiny in academic circles too. But the
judgment is yet to stand the Supreme test of judiciary scrutiny as the aggrieved Banks and
concerned regulatory bodies (RBI and Indian Bank Association) have challenged the decision before
the Supreme Court. In the interim, the legality of loan purchases is under cloud till now. I feel the
recent pronouncement of the Gujarat High Court has misinterpreted the term ‘debt’ from legal as
well as accounting point of view. A loan item or the borrower is an asset of a bank and not a debt.
Thus, de-facto the assignment of loan (good or bad) amounts to transfer of asset and not debt. Even
RBI considers interse NPA assignment between banks to be a significant tool for resolving the issue
of Non Performing Assets and in the interest of Banking policy .The decision given by the Honorable
Courts in the cases that have been cited below (footnote16) were in favor of “assignment of NPAs
between banks. Measures to control NPAs menace A lasting solution to the problem of NPAs can be
achieved only with proper credit assessment and risk management mechanism. It is necessary that
the banking system is equipped with prudential norms to minimize if not completely avoid the
problem of credit risk. Effective management of NPA rather than elimination is prudent. All these
issues gave the passage of evolution of the Securitisation and Reconstruction of Financial Assets and
enforcement of Security Interest Act (SARFAESI), 2002 . It is a unique piece of legislation which has
far reaching consequences. Securitisation in India is still in a nascent stage but has potential in areas
like mortgage Backed securitisation. This act has a overriding power over the other legislation.
SARFAESI ACT was promulgated to regulate the financial assets and enforcement of security interest
and for matters connected therewith or incidental thereto. The main purpose of this act is to enable
the creditors take possession of the secured assets and to deal with them without the intervention
of the court. No doubt this Act was challenged in various courts on ground that it was loaded heavily
in favour of lenders, giving little chance to the borrowers to explain their views once recovery
process is initiated under the legislation. The major problem with the Indian banking system is that
they depend largely upon lending and investments. The banks in the developed countries do not
depend upon this income whereas 86 percent of income of Indian banks is accounted from interest
and the rest of the income is fee based. The banker can earn sufficient net margin by investing in
safer securities though not at high rate of interest. It facilitates for limiting of high level of NPAs
gradually. It is possible that average yield on loans and advances net default provisions and services
costs do not exceed the average yield on safety securities because of the absence of risk and service
cost. The corporate debt restructuring is also one of the methods suggested for the reduction of
NPAs. Its objective is to ensure a timely and transparent mechanism for restructure of corporate
debts of viable corporate entities affected by the contributing factors outside the purview of DRT
and other legal proceedings for the benefit of concerned. The problem of non -performing loans
created due to systematic banking crisis world over has become acute. Focused measures to help
the banking system to realise its NPAs has resulted into the creation of specialised bodies called
Asset Management Companies which in India have been named Asset Reconstruction Companies
(ARC’s) The main objective of ARCs is to act as 1) A agent for any bank or financial institution for the
purpose of recovering their dues from the borrowers. 2) A manager of the borrowers’ asset taken
over by banks or financial institution. 3) The receiver of properties of any bank or financial
institution. 4) There have been instances of banks extending credit to doubtful debtors (who
deliberately default on debt) and getting kickbacks for the same. Ineffective Legal mechanisms and
inadequate internal control mechanisms have made this problem grow – quick action has to be
taken on both counts so that both the defaulters and the authorising officer are punished heavily.
Without this, all the mechanisms suggested above may prove to be ineffective. Conclusion The
contaminated portfolio is definitely a bane for any bank. It puts severe dent on the liquidity and
profitability of the bank where it is out of proportion. It is needless to mention, that a lasting
solution to the problem of NPAs can be achieved only with proper credit assessment and risk
management mechanism. It is necessary that the banking system is to be equipped with prudential
norms to minimize if not completely to avoid the problem of NPAs. The onus for containing the
factors leading to NPAs rests with banks themselves. This will necessitates organizational
restructuring, improvement in the managerial efficiency and skill up gradation for proper assessment
of credit worthiness It is better to avoid NPAs at the nascent stage of credit consideration by putting
in place of rigorous and appropriate credit appraisal mechanisms.

When bad loans are sown in good times; Indian banks may not be
prepared to deal with the non-performing assets that are slowly
but surely piling up. Is Indian banking's own subprime crisis in the
works?

Abstract (Summary)
The OTD model has failed miserably in the global marketplace, agrees B. Sambamurthy,
Chairman & Managing Director of the state-owned Corporation Bank. The 57-year-old
veteran, whose banking career spans over three decades, isn't perturbed by the fear and
uncertainty around him. Reason? Corporation Bank, along with most other public sector
banks (PSBs), has preferred the OTH model, where retail assets stay in the originating banks'
books. On the other hand, a few large private sector banks, along with the foreign banks,
experimented with the global tools of securitisation to transfer retail assets (and also the risk
that comes along with) from their book to other entities. The likes of Citi, ICICI Bank and
Kotak in a way, were aping the global OTD model, although it never developed into a
phenomenon due to several disincentives put in place by the Reserve Bank of India.

Take, for instance, the country's second largest bank, ICICI Bank, which saw a massive 78
per cent jump in its gross NPAs from Rs 3,114 crore in March 2007 to Rs 5,552 crore a year
later. The breeding ground of NPAs clearly is the unsecured loan portfolio, where defaults are
across the board in small-ticket size loans. Many banks have already put a stop on issuing
such fresh loans. The next big danger spot where widespread defaults are expected is credit
cards, a segment that banks wouldn't want to exit as it is a lucrative one. What's more,
although two-wheeler and threewheeler financing on paper is considered secured lending,
experts say it is not too different from unsecured lending, which explains why NPAs are on
the higher side. As for home loans, margins are low, and bankers don't consider them an
attractive business any more.

One crucial difference between the NPAs in the West and Indian bad loans is the role of
directselling agents (DSAs) back home. Whilst the US banking debacle can be attributed
solely to the OTD model, back home DSAs, too, have to carry the can for creating
questionable and risky portfolios. But not everybody is willing to lay the blame squarely at
the DSA's doorstep. Says K.S. Sridhar, Chief Risk Officer, IndusInd Bank: DSA as a model
cannot be faulted for customer acquisition, but one should exercise due caution in using
external collection agencies.
Full Text
 (1248  words)
(Copyright (c) Living Media India Limited. Not to be reprinted or reused in any way without
prior permission of the publisher.)

The originate-to-distribute model can leave lenders (banks) with weaker incentives to
maintain strong underwriting standards. This system is not only a potential source of risk to
the financial system but also raises concerns regarding consumer protection.Federal Reserve
Governor Randall S. Kroszner at the Consumer Bankers Association in Washington DC in
November 2007 on The Challenges Facing Subprime Mortgage Borrowers.

Financial institutions originated loans that they then bundled into securities and sold to other
investors. With hindsight, it is clear that this originate-to-distribute model suffered severe
incentive problems the originator had insufficient incentive to ensure the quality of the loans,
since someone else ultimately held them.

Janet L. Yellen, President and CEO, Federal Reserve Bank of San Francisco, at the
University of California's San Diego Economics Roundtable in July 2008.

The crisis in the US financial sector can be traced back to the originate-to-distribute (OTD)
model as opposed to originate-tohold (OTH) that banks followed. Simply put, OTD allows
banks to lend more (or originate more loans) without violating lending limits (as they
distribute the loans rather than hold them). In essence, many of these US banks were issuing
loans to customers without expanding their capital. These loans were packaged and sold to
investors like hedge funds and pension funds. Once these loans were offloaded, there was, of
course, room again to issue fresh loans. End-result? The subprime crisis as holders of the
underlying assets (mortgage loans) defaulted once housing prices crashed.

The OTD model has failed miserably in the global marketplace, agrees B. Sambamurthy,
Chairman & Managing Director of the state-owned Corporation Bank. The 57-year-old
veteran, whose banking career spans over three decades, isn't perturbed by the fear and
uncertainty around him. Reason? Corporation Bank, along with most other public sector
banks (PSBs), has preferred the OTH model, where retail assets stay in the originating banks'
books. On the other hand, a few large private sector banks, along with the foreign banks,
experimented with the global tools of securitisation to transfer retail assets (and also the risk
that comes along with) from their book to other entities. The likes of Citi, ICICI Bank and
Kotak in a way, were aping the global OTD model, although it never developed into a
phenomenon due to several disincentives put in place by the Reserve Bank of India.

Still, that didn't stop a clutch of banks using both the OTD and OTH frameworks from going
all out to hawk loans to consumers (home loans, car loans, personal loans, education loans,
loans for vacations et al). According to credit rating major, CRISIL, the retail finance
industry recorded an unprecendented compounded annual growth rate of more than 30 per
cent in the March 2003-07 period. The outstanding retail advances stood at Rs 6,00,000 crore
as on March 2007.
Now for the bad news. The rating agency estimates that the proportion of gross non-
performing assets (NPAs) to retail advances will rise to 4 per cent in March 2009, from 2.7
per cent in March 2007. Here's why, in the words of the CEO of a small private sector bank:
Some banks were overaggressive on pricing and also extended credit to riskier classes like
self-employed and high-risk customer in Tier II and Tier III cities. The scramble to build a
retail portfolio resulted in banks deviating from prudent lending practices. The loan to value
(LTV, which is the loan amount as a percentage of the value of the property mortgaged) for
mortgages increased from 85 per cent to as high as 100 per cent; and the installmentto-
income (IIR) ratio also jumped from 30-35 per cent of income to a high of 60 per cent.

Clearly, inflationary pressures, coupled with rising interest rates, have shrunk the consumer's
wallet. As they end up spending more on household expenditure, they have less left over for
payments of monthly installments. Whilst it may be too early yet to ring the alarm bells,
what's worrying is the repayment age getting extended to beyond 60 years. As Deepak
Saruparia, Deputy Managing Director, Bank of Rajasthan, says: The risk has increased in the
system. The bulk of the NPAs is distributed amongst a few large players.

The problem within

Originate and distribute model of lending has failed globally

Too much reliance on DSAs and dealers for garnering business

Banks resorted to higher loan to value (LTV) model in mortgages

Indiscriminate lending to high-risk customers in Tier II and Tier III cities

Defaults in unsecured lending are on the rise, especially of personal loans and credit cards

Low-margin home loan business suddenly turning unattractive

Take, for instance, the country's second largest bank, ICICI Bank, which saw a massive 78
per cent jump in its gross NPAs from Rs 3,114 crore in March 2007 to Rs 5,552 crore a year
later. The breeding ground of NPAs clearly is the unsecured loan portfolio, where defaults are
across the board in small-ticket size loans. Many banks have already put a stop on issuing
such fresh loans. The next big danger spot where widespread defaults are expected is credit
cards, a segment that banks wouldn't want to exit as it is a lucrative one. What's more,
although two-wheeler and threewheeler financing on paper is considered secured lending,
experts say it is not too different from unsecured lending, which explains why NPAs are on
the higher side. As for home loans, margins are low, and bankers don't consider them an
attractive business any more.

The turmoil on Wall Street and the ensuing uncertainty have made a stringent control over
asset quality the #1 priority for banks. Paresh Sukthankar, Executive Director, HDFC Bank,
says: We always try to balance our growth in terms of volume or market share with margin
and asset quality.

An example of this: HDFC Bank has a system of monitoring portfolio quality on an ongoing
basis to ensure portfolio stability. We also take immediate course correction measures if we
find actual portfolio losses exceeding expected losses, adds Kaizad Bharucha, Country Head,
Wholesale Credit & Market Risk, and Retail Credit Risk Policy, HDFC Bank.

We are extremely cautious in the unsecured loan segment, especially credit cards where we
are reaching out to our existing borrowers, says Sambamurthy. Corporation Bank has the
lowest NPA amongst scheduled commercial banks, at just 0.32 per cent.

One crucial difference between the NPAs in the West and Indian bad loans is the role of
directselling agents (DSAs) back home. Whilst the US banking debacle can be attributed
solely to the OTD model, back home DSAs, too, have to carry the can for creating
questionable and risky portfolios. But not everybody is willing to lay the blame squarely at
the DSA's doorstep. Says K.S. Sridhar, Chief Risk Officer, IndusInd Bank: DSA as a model
cannot be faulted for customer acquisition, but one should exercise due caution in using
external collection agencies.

Meanwhile, there may be another bubble building alongside retail that of small & medium
enterprises (SMEs). Such companies are under tremendous stress because of lower demand
and higher interest rates. Many are in the midst of expansion, which is two to three times
their current capacity, says an analyst.

S.S. Tarapore, a former Deputy Governor of the Reserve Bank, recently sounded the alarm
bells when he warned that the ground realities are that the Indian banking system is extremely
vulnerable and nonperforming assets are going to pile up in the next few years . The good
news for banks is they still have time to clean up their acts, and their balance sheets.