NON-PERFORMING ASSETS

ASSET AND LIABILITY MANAGEMENT BY THE BANKS

NON-PERFORMING ASSETS
 INTRODUCTION:
 A Non-performing asset (NPA) is defined as a credit facility
in respect of which the interest or installment of Bond
finance principal has remained ‘past due’ for a specified
period of time.
 Once the borrower has failed to make interest or principal
payments for 90 days the loan is considered to be a non-
performing asset.
 Non-performing assets are problematic for financial
institutions since they depend on interest payments for
income.
 Troublesome pressure from the economy can lead to sharp
increase in NLP’s and often results in massive write-downs.
 With a view to moving towards international best practices and to ensure
greater transparency, it has been decided to adopt the ‘90 days overdue’
norm for identification of NPA from the year ending March 31, 2004.
 Interest of principal remain overdue for the period of more than 91 days
in respect of a term loan.
 The account remains ‘out of order’ for a period of more than 90 days, in
respect of an Overdraft/Cash Credit.
 Bills remains overdue for a period of more than 90 days in the case of
bills purchased or discounted.
 Interest of principal remains overdue for two harvest seasons but not
exceeding two and a half years in the case of an advance granted for
agricultural purposes.
 Any amount to be received remains overdue for a period of more than 90
days in respect of other accounts.
 Non submission of Stock Statements for 3 Continuous Quarters in case of
Cash Credit Facility.
 No active transactions in accounts like CC, OD, EPC for more than 91 days.
 REASONS FOR OCCURRENCE OF NPA’s:
 NPA’s result from what are termed as “Bad Loans”. Default in the
financial parlance is the failure to meet financial obligations (non-
payment of loan or installment).
 Usual banking operations
 A banking crisis (as happened in USA, South Asia and Japan)
 Over hang component (due to environmental reasons)
 Incremental component (due to internal bank management)

 PROBLEMS CAUSED BY NPA’s:

 Depositors do not get rightful returns and many times may lose
uninsured deposits.
 Bank shareholders are adversely affected.
 Bad loans imply redirecting of funds from good projects to bad
ones. Hence, the economy suffers due to loss of good projects and
failure of bad investments.
 When bank do not get loan repayment or interest payments,
liquidity problems may ensue.
 OBJECTIVES OF NPA:
 Even though bank serves social objective through it’s
priority sector lending by mass branch networks and
employment generation therefore, maintaining asset
quality and profitability is critical for them.
 A major threat to banking sector is prevalence of Non-
performing assets (NPA). They represent bad loans when
the borrowers fail to satisfy their repayment obligations.
 Efficient Operations.
 Psychology of bank workers with respect to the
disposition of funds.
ADVANTAGES:
 Betterand speedier realization
from NPA
 Transparency and visibility of
information
 Better efficiencies in management
of NPA
 Robust data collection for use by all
lenders
 Attracting positive investors across
the globe
 Enabling lenders to take informed
decision
 Revival of a sick unit or industry
 Help from facilitators
DISADVANTAGES:
 Reduced Income
Unrecoverable Principal
 Reduced Cash Flow
 Negative Indicator
ASSET AND LIABILITY MANAGEMENT BY BANKS
 INTRODUCTION:
 The process by which an institution manages it’s
balance sheet in order to allow alternative interest rates
and liquidity scenarios.
 Banks and other financial institutions provide services
which expose them to various kinds of risks like credit,
interest risk and liquidity risk.
 Asset-liability management models enable institutions
to measure and monitor risk and provide suitable
strategies for their management.
 Asset-liability management builds up Assets and
Liabilities of the bank based on the concept of Net
Interest Income (NII) or Net Interest Margin (NIM).
EVOLUTION OF ALM:
In the 1940’s and the 1950’s there was an
abundance of funds in the banks in the
form of demand and saving deposits.
Hence, the focus then was mainly on asset
management.

 But as the availability of low cost funds

started to decline, liability management
became the focus of bank management
efforts.

 In the 1980’s volatility of interest rates in

USA and Europe caused the focus to
broaden in order to include the issue of
interest rate risk. ALM began to extend
beyond treasury to cover the loan and
deposit functions.

 Banks started to concentrate more on

the management of both sides of the
balance sheet.
 OBJECTIVES OF ALM:
 The task of ALM is not to eliminate risk but
to manage it.
 ALM is an integral part of banking business
and not just an exercise in meeting regulatory
requirements.
 ALM involves alteration of balance sheets in
a dynamic manner to manage risks.

A sound ALM system for the bank should encompass:

Review of credit portfolio and credit risk

management
 Review of investment portfolio and risk
management
 Risk management of forex operations
 Management of liquidity risk
 Fixation of interest product pricing of both
assets and liabilities
 Review of interest rate out-looks
 CORE FUCTIONS OF ALM:
 MANAGING GAPS:-
 The objective is to measure the direction and extent of
asset-liability mismatch through funding or maturity gap.
 This aspect of ALM stresses the importance of balancing
maturities as well as cash flows or interest rates for a
particular set time horizon.
 For the management of interest rate risk it may take the
form of matching maturities and interest rate of loans and
investments with the maturities and interest rate of deposit,
equity and external credit in order to maintain adequate
profitability. In other words, it is the management of the
spread between interest rate sensitive assets and interest
rate sensitive liabilities.
 STATIC/DYNAMIC GAP MEASUREMENT TECHNIQUES:-

 Gap analysis suffers from only covering future gap direction of current
existing exposures and exercise of options at different point of time.
 Dynamic gap analysis enlarges the perimeter for a specific asset by
including ‘what if’ scenarios on making assumptions on new volumes.

 Examples are as follows-

 Changes in business activity
 Future path of interest rate
 Changes in pricing
 New pre-payment transactions
TOOLS OF ALM:
 GAP ANALYSIS:-- This is generally used for
quantifying the rate sensitive groups only
(current deposits, float funds). In other
words, it is the “excess” of interest sensitive
assets over interest sensitive liabilities or
vice-versa.
 DURATION ANALYSIS:- Under this method,
impact of changes in interest rate on the
market value of assets and liabilities is taken
into consideration.
 VALUE AT RISK (VAR) METHOD:- This
method is variant of the practice of ‘Market-
to-Market’ approved securities based on
Yield- to Maturity.
 RISK MANAGEMENT:- Under this process,
the risk profiles of assets and liabilities are
evaluated to ensure that they are within the
acceptable levels of risk. The availability of
hedging mechanisms (derivative
instruments) would facilitate risk
management.
 This empirical study is endeavoring to appraise the
changing perception of the banks in recognizing and
conflicting the risks and maintaining Assets-Liabilities
management.
 The financial strength of the Indian banking sector plays an
effective role in propelling the economic growth of the
country.
 It exhausts to assess the effectiveness of Asset Liability
Management as a strategy of the essence to the growth
and expansion of the Indian banking sector in the economy
in making the study significant. It is with this aim that an
attempt has been made in this empirical research study.