Banking and Financial Institution
profits, rising level of bad debts, declining sales.
A nonperforming asset (NPA) refers to a classification for loans
or advances that are in default or in arrears.
NPA is an asset which ceases to generate income for the bank. It
means an advance or credit facility in respect of which the
interest or instalment of principal remain overdue for a period of
more than 90 days with effect from 31st march 2004.
Nonperforming assets (NPAs) are recorded on a bank's
balance sheet after a prolonged period of non-payment by the
borrower.
Note: NPAs place financial burden on the lender; a significant
number of NPAs over a period of time may indicate to
regulators that the financial health of the bank is in jeopardy.
NPAs can be classified as a substandard asset, doubtful asset,
or loss asset, (types of NPA) depending on the length of time
overdue and probability of repayment.
Note: Lenders have options to recover their losses, including
taking possession of any collateral or selling off the loan at a
significant discount to a collection agency.
Note: A loan is in arrears when principal or interest payments
are late or missed. A loan is in default when the lender
considers the loan agreement to be broken and the debtor is
unable to meet his obligations.
Note: After a prolonged period of non-payment, the lender will
force the borrower to liquidate any assets that were pledged as
part of the debt agreement. If no assets were pledged, the lender
might write-off the asset as a bad debt and then sell it at a
discount to a collection agency. In most cases, debt is classified
as nonperforming when loan payments have not been made for
a period of 90 days. While 90 days is the standard, the amount
of elapsed time may be shorter or longer depending on the
terms and conditions of each individual loan. A loan can be
classified as a nonperforming asset at any point during the term
of the loan or at its maturity.
Types of Non-Performing Assets (NPA)
 Overdraft and cash credit (OD/CC) accounts left out-
of-order for more than 90 days
 Agricultural advances whose interest or principal
installment payments remain overdue for two
crop/harvest seasons for short duration crops or
overdue one crop season for long duration crops.
 Expected payment on any other type of account is
overdue for more than 90 days.
Recording Non-Performing Assets (NPA)
Note: Banks are required to classify nonperforming assets into
one of three categories according to how long the asset has
been non-performing: sub-standard assets, doubtful assets, and
loss assets.
A sub-standard asset is an asset classified as an NPA for less
than 12 months. A doubtful asset is an asset that has been non-
performing for more than 12 months.
Loss assets are loans with losses identified by the bank, auditor,
or inspector that need to be fully written off. They typically have
an extended period of non-payment, and it can be reasonably
assumed that it will not be repaid.
Impact of NPA
 They do not generate income
 They enhance the administrative, legal and recovery
costs of loans
 They reduce profitability of the lending bank
 They effect banks credibility and image
 They adversely affect decision making for fresh loans
Early Indicators of NPA
• Financial warning signal - default in repayment, falling
• Operational warning signal - underutilization of capacity,
frequent labour problems, over stocking
• Banking warning signals - frequent requests for further loans,
delay in payment of interest or instalment due, reduction in
transactions, dishonour of cheques, opening account with other
banks, etc.
• Managerial warning signal - poor financial control, frequent
change in ownership, undertaking of undo risks, window
dressing.
• External warning signal - economic recession, change in
government policies, new competition.
Factors Responsible for NPA
1. Internal Factors
 Diversion of funds by the borrowers
 Delay and consequent increase in cost of the
project
 Business failure
2. External Factors
 Recession
 Shortage of input/ power
 Rise in prices of inputs
Techniques for Managing NPA
 Ensure that loans are diversified across sectors
 Loans are granted to credit worthy borrowers
 Improving its monitoring system
 React to early warning signals
 Knowing clients profile thoroughly
 Adapting credit rating system
Banking Legislations in India
 The negotiable instruments Act 1881
 The banking regulation Act 1949
 The reserve bank of India Act 1934
Banking Ombudsman Scheme
 A banking ombudsman is a person appointed by the
reserve bank of India to redress customer complaints
against certain deficiencies in banking services.
 It is to solve and settle complaints relating to the
provisions of barking services.
Online banking allows a user to conduct financial transactions
via the Internet. Online banking is also known as Internet
banking or web banking.
Online banking offers customers almost every service
traditionally available through a local including deposits,
transfers, and online bill payments.
Note: Virtually every banking institution has some form of
online banking, available both on desktop versions and through
mobile apps.
Importance of e-banking
Banks
1. Lesser transaction costs - electronic transactions are
the cheapest modes of transaction
2. A reduced margin for human error - since the
information is relayed electronically, there is no room
for human error
3. Lesser paperwork - digital records reduce paperwork
and make the process easier to handle. Also, it is
environment-friendly.
4. Reduced fixed costs- A lesser need for branches which
translates into a lower fixed cost
5. More loyal customers - since e-banking services are
customer-friendly, banks experience higher loyalty
from its customers.
Customers
1. Convenience - a customer can access his account and
transact from anywhere 24x7x366.
 2. Lower cost per transaction - since the customer does
not have to visit the branch for every transaction, it
saves him both time and money.
3. No geographical barriers - In traditional banking
systems, geographical distances could hamper certain
banking transactions. However, with e-banking,
geographical barriers are reduced.
Businesses
1. Account reviews - Business owners and designated
staff members can access the accounts quickly using an
online banking interface. This allows them to review
the account activity and also ensure the smooth
functioning of the account.
2. Better productivity - Electronic banking improves
productivity. It allows the automation of regular
monthly payments and a host of other features to
enhance the productivity of the business.
3. Lower costs - Usually, costs in banking relationships
are based on the resources utilized. If a certain business
requires more assistance with wire transfers, deposits,
etc., then the bank charges it higher fees. With online
banking, these expenses are minimized.
4. Lesser errors - Electronic banking helps reduce errors
in regular banking transactions. Bad handwriting,
mistaken information, etc. can cause errors which can
prove costly. Also, easy review of the account activity
enhances the accuracy of financial transactions.
5. Reduced fraud - Electronic banking provides a digital
footprint for all employees who have the right to
modify banking activities. Therefore, the business has
better visibility into its transactions making it difficult
for any fraudsters to play mischief.
Electronic banking is a form of banking in which funds are
transferred through an exchange of electronic signals rather than
through an exchange of cash, checks, or other types of paper
documents.
Note: Transfers of funds occur between financial institutions
such as banks and credit unions. They also occur between
financial institutions and commercial institutions such as stores.
Whenever someone withdraws cash from an automated teller
machine (ATM) or pays for groceries using a debit card (which
draws the amount owed to the store from a savings or checking
account), the funds are transferred via electronic banking.
Forms of E Banking
 Internet banking
 Mobile banking
 Telephone banking
 Home banking
Credit card
A credit card is an instrument which provides instantaneous
credit facilities to its holder to purchase goods or services from
business establishments enrolled as members of the credit card
system.
Debit card
It also payment card. It is used to obtain cash, goods or services
automatically deviating the payments to the card holder's bank
account instantly up to the credit balance which exists in the
customer's bank account.
Electronic Fund Transfer
It is scheme of RBI introduced in 1996
It helps banks to offer their customers money transfer service
from one account to another of a bank branch both intercity and
intercity and also from one account of one bank to another
account of another bank in the same city or different cities.
Two Types of Banking Websites
1. Informational Websites - These websites offer general
information about the bank and its products and
services to customers.
2. Transactional Websites - These websites allow
customers to conduct transactions on the bank's
website. Further, these transactions can range from a
simple retail account balance inquiry to a large
business-to-business funds transfer. The following table
lists some common retail and wholesale e-banking
services offered by banks and financial institutions.
Common E-Banking Services
Retail Services
 Account management
 Bill payment
 New account opening
 Consumer wire transfers
 Investment/Brokerage services
 Loan application and approval
 Account aggregation
Wholesale Services
 Account management
 Cash management
 Small business loan applications, approvals, or
advances
 Commercial wire transfers
 Business-to-business payments
 Employee benefits/ pension administration
A financial instruments is any contract that gives rise to a
financial asset of one entity and a financial liability or equity
instrument of another entity.
Contract refers to an agreement between two or more parties
that has clear economic consequences that the parties have little,
if any, discretion to avoid, usually because the agreement is
enforceable by law.
Financial instruments include primary instruments and
derivative financial instruments. Based on the definition,
financial instruments include financial assets, financial
liabilities, equity instruments and derivatives. Derivatives
include financial options, futures and forwards, interest rate
swaps and currency swaps.
 Financial Assets
A financial asset is any asset that is:
 Cash
 Equity instruments of another entity
 Receivable
Some of the most commonly encountered financial instruments
representing financial assets are the following:
1. Cash on hand and in banks
a) Petty cash - refers to cash balances kept on
hand at various locations to pay for minor
expenditures such as postage and other small
out-of-pocket expenditures.
b) Demand, savings and time deposits -
represent amounts on deposit in checking,
savings and time deposit accounts
respectively. Time deposits are placements
covering a relatively long period of time.
c) Undeposited checks - are checks payable to
the enterprise or bearer but not yet presented
to the bank for payment.
d) Foreign currencies - may not be used to buy
goods and services in any country other than
the one in which it is printed, unless the
government of that country agrees to use it.
e) Money orders - are financial instruments
similar to bank drafts but are drawn generally
from authorized post offices or other financial
institutions.
f) Bank drafts - are commitment by banking
institutions to advance funds on demand by
the party to whom the draft was directed.
 2. Accounts, notes and loans receivable and investment 2. Forward Contracts - is a customized contract between
in bonds and other debt instruments issued by other two parties to buy or sell an asset at a specified price on
entities: a future date. A forward contract can be used for
a) Trade-receivables (signed delivery receipts hedging or speculation, although its non-standardized
and sales invoice) nature makes it particularly apt for hedging.
b) Promissory notes
c) Bond certificates A forward contract is similar to a future
3. Interest in shares or other equity instruments issued contract but differ in three ways:
by other entities a) A forward contract calls for delivery on a specific
a) Stock certificates date, whereas a future contract permits the seller to
b) Publicly listed securities decide later which specific day within the specified
month will be the delivery date (if it gets as far as
4. Derivative Financial Assets actual delivery before it is closed out).
a) Future contracts b) Unlike a future contract, a forward usually is not
b) Forward contracts traded on a market exchange.
c) Call options c) Unlike a future contract, forward contracts does
d) Foreign currency futures not call for a daily cash settlement for price
e) Interest rate swaps changes in the underlying contract. Gains and
losses on forward contracts are paid only when
 Financial Liabilities they are closed out.
A financial liability is any liability that is
1. A contractual obligation 3. Call options - are financial contracts that give the
a) To deliver cash or another financial asset option buyer the right, but not the obligation, to buy a
to another entity; or stock, bond, commodity or other asset or instrument at
b) To exchange financial assets or financial a specified price within a specific time period.
liabilities with another entity under
conditions that are potentially 4. Foreign Currency Futures - foreign currency
unfavourable to the entity; or frequently is denominated in the currency of the lender.

2. A contract that will or may settled in the entity's
own equity instruments and is:
a) A non- derivative for which the entity is
or may be obligated to deliver a variable
number of the entity's own instruments; or
b) A derivative that will or may be settled
other than by the exchange of a fixed
amount of cash or another financial asset
for a fixed number of the entity's own
equity instruments.
5. Interest Rate Swaps - is a forward contract in which
one stream of future interest payments is exchanged for
another based on a specified principal amount. It
usually involves the exchange of a fixed interest rate
for a floating rate, or vice versa, to reduce or increase
exposure to fluctuations in interest rates or to obtain a
marginally lower interest rate than would have been
possible without the swap. A swap can also involve the
exchange of one type of floating rate for another, which
is called a basis swap.

Examples of Financial Liabilities are the following:

 Accounts and notes payable, loans from other entities
and bonds and other debt instruments issued by the
entity
 Derivative financial liabilities
 Obligations to deliver own shares worth a fixed amount
of cash
 Some derivatives on own equity instruments.

 Equity Instruments
An equity instrument is any contract that evidence a
residual interest in the assets of an entity after deducting all
of its liabilities.

Examples of Equity Instruments are:

 Ordinary shares
 Preference shares
 Warrants or written call option that allow the holder to
subscribe or purchase ordinary shares in exchange for a
fixed amount of each or another financial asset.

 Derivative Financial Instruments

Derivatives are financial instruments that "derive" their
value on contractually required cash flows from some other
security or index.

Five Major Types of Financial Derivatives

1. Future Contracts - is an agreement between a seller
and a buyer that requires that seller to deliver a
particular commodity at a designated future date, at a
predetermined price. These contracts are actively
treated on regulated future exchanges and are generally
referred to as "commodity future contract".