NPAs reIlect the perIormance oI banks.

A high level oI NPAs suggests high probability oI a large number oI credi

deIaults that aIIect the proIitability and net-worth oI banks and also erodes the value oI the asset. The NPA growth
involves the necessity oI provisions, which reduces the over all proIits and shareholders value.
The issue oI Non PerIorming Assets has been discussed at length Ior Iinancial system all over the world. The
problem oI NPAs is not only aIIecting the banks but also the whole economy. In Iact high level oI NPAs in Indian
banks is nothing but a reIlection oI the state oI health oI the industry and trade.
The paper deals with understanding the concept oI NPAs, its magnitude and major causes Ior an account becoming
non-perIorming, projection oI NPAs over next three years in Public sector banks and concluding remarks.
CAUSES FOR NON-PERFORMING ASSETS IN PUBLIC SECTOR BANKS
Introduction
Granting oI credit Ior economic activities is the prime duty oI banking. Apart Irom raising resources through Iresh
deposits, borrowings and recycling oI Iunds received back Irom borrowers constitute a major part oI Iunding credi
dispensation activity. Lending is generally encouraged because it has the eIIect oI Iunds being transIerred Irom the
system to productive purposes, which results into economic growth. However lending also carries a risk called cre
risk, which arises Irom the Iailure oI borrower. Non-recovery oI loans along with interest Iorms a major hurdle in
process oI credit cycle. Thus, these loan losses aIIect the banks proIitability on a large scale. Though complete
elimination oI such losses is not possible, but banks can always aim to keep the losses at a low level.
Non-perIorming Asset (NPA) has emerged since over a decade as an alarming threat to the banking industry in ou
country sending distressing signals on the sustainability and endurability oI the aIIected banks. The positive result
the chain oI measures aIIected under banking reIorms by the Government oI India and RBI in terms oI the two
Narasimhan Committee Reports in this contemporary period have been neutralized by the ill eIIects oI this surging
threat. Despite various correctional steps administered to solve and end this problem, concrete results are eluding.
is a sweeping and all pervasive virus conIronted universally on banking and Iinancial institutions. The severity oI
problem is however acutely suIIered by Nationalised Banks, Iollowed by the SBI group, and the all India Financia
Institutions.
Objectives of the study

i. To understand the meaning & nature oI NPAs.
ii. To examine the causes Ior NPAs in public sector banks.
iii. To project the NPAs in public sector banks over next three years using Trend Analysis as a tool.
Methodology
In order to meet the Third objective, the method oI Moving Averages is been used, Irom which we arrive at a Tre
Analysis. While the rationale behind selection oI 'Three year Moving Average' method is because oI the
availability oI the data. The data available was Irom the ten years and needless to say that Ior such a data a 'Six yea
Moving average' or a 'Eight year Moving Average' will not work out.
Meaning of NPAs
An asset is classified as Non-performing Asset (NPA) if due in the form of principal and interest are not paid by th
borrower for a period of 180 days. However with effect from March 2004, default status would be given to a
borrower if dues are not paid for 90 days. If any advance or credit facilities granted by banks to a borrower becom
non-performing, then the bank will have to treat all the advances/credit facilities granted to that borrower as non-
performing without having any regard to the fact that there may still exist certain advances / credit facilities havin
performing status.
Though the term NPA connotes a Iinancial asset oI a commercial bank, which has stopped earning an expected
reasonable return, it is also a reIlection oI the productivity oI the unit, Iirm, concern, industry and nation where tha
asset is idling. Viewed with this perspective, the NPA is a result oI an environment that prevents it Irom perIormin
up to expected levels.
The deIinition oI NPAs in Indian context is certainly more liberal with two quarters norm being applied Ior
classiIication oI such assets. The RBI is moving over to one-quarter norm Irom 2004 onwards.
Magnitude of NPAs
Inn India, the NPAs that are considered to be at higher levels than those in other countries have oI late, attracted th
attention oI public. The Indian banking system had acquired a large quantum oI NPAs, which can be termed as
legacy NPAs.
NPAs seem to be growing in public sector banks over the years.
The Iollowing are the Iigures oI gross and net NPAs oI public sector banks Irom the period 1993 2002

(Table 1)
NPAs in Public Sector Banks
End March Gross NPAs of Gross
Advances
to Total
Assets
Net NPAs of Net
Advances
of Total
Assets
1993 39,253 23.2 11.8 18,077 11.3 4.6
1994 41,041 24.8 10.8 18,903 12.87 5.1
1995 38,385 19.5 8.7 17,567 10.7 4.0
1996 41,661 18.0 8.2 18,297 8.9 3.6
1997 43,577 17.8 7.8 20,285 9.2 3.6
1998 45,653 16.0 7.0 21,232 8.2 3.3
1999 58,554 15.6 6.8 24,211 8.85 3.1
2000 59,952 14.0 6.6 26,188 7.97 3.0
2001 68,238 13.1 6.4 28,032 6.8 2.6
2002 81,889 12.8 6.0 29,874 6.1 2.2

A distinction is oIten made between Gross NPA and Net NPA. Net NPA is obtained by deducting items like intere
due but not recovered, part payment received and kept in suspense account etc., Irom Gross NPA.
As shown in the above table 1 over the years the NPAs as a percentage oI net advances and total assets have been
declining but actual numbers are increasing.
Dealing with NPAs involves two sets oI policies

1. Relating to existing NPAs
2. To reduce Iresh NPA generation.
As Iar as old NPAs are concerned, a bank can remove it on its own or sell the assets to AMCs to clean up its balan
sheet. For preventing Iresh NPAs, the bank itselI should adopt proper policies.
Causes for Non Performing Assets
A strong banking sector is important Ior a Ilourishing economy. The Iailure oI the banking sector may have an
adverse impact on other sectors. The Indian banking system, which was operating in a closed economy, now Iaces
challenges oI an open economy.
On one hand a protected environment ensured that banks never needed to develop sophisticated treasury operation
and Asset Liability Management skills.
On the other hand a combination oI directed lending and social banking relegated proIitability and competitivenes
the background. The net result was unsustainable NPAs and consequently a higher eIIective cost oI banking servic
One oI the main causes oI NPAs into banking sector is the directed loans system under which commercial banks a
required a prescribed percentage oI their credit (40) to priority sectors. As oI today nearly 7 percent oI Gross NP
are locked up in 'hard-core' doubtIul and loss assets, accumulated over the years.
The problem India Faces is not lack oI strict prudential norms but
i. The legal impediments and time consuming nature oI asset disposal proposal.
ii. Postponement oI problem in order to show higher earnings.
iii. Manipulation oI debtors using political inIluence.
Macro Perspective Behind NPAs
A lot oI practical problems have been Iound in Indian banks, especially in public sector banks. For Example, the
government oI India had given a massive wavier oI Rs. 15,000 Crs. under the Prime Minister ship oI Mr. V.P. Sin
Ior rural debt during 1989-90. This was not a unique incident in India and leIt a negative impression on the payer o
the loan.
Poverty elevation programs like IRDP, RREP, SUME, SEPUP, JRY, PMRY etc., Iailed on various grounds in
meeting their objectives. The huge amount oI loan granted under these schemes were totally unrecoverable by ban
due to political manipulation, misuse oI Iunds and non-reliability oI target audience oI these sections. Loans given
banks are their assets and as the repayment oI several oI the loans were poor, the quality oI these assets were stead
deteriorating. Credit allocation became 'Lon Melas', loan proposal evaluations were slack and as a result repaymen
were very poor.
There are several reasons Ior an account becoming NPA.

* Internal Iactors
* External Iactors
Internal factors:

1. Funds borrowed Ior a particular purpose but not use Ior the said purpose.
2. Project not completed in time.
3. Poor recovery oI receivables.
4. Excess capacities created on non-economic costs.
5. In-ability oI the corporate to raise capital through the issue oI equity or other debt instrument Irom capital mark
6. Business Iailures.
7. Diversion oI Iunds Ior expansion\modernization\setting up new projects\ helping or promoting sister concerns.
8. WillIul deIaults, siphoning oI Iunds, Iraud, disputes, management disputes, mis-appropriation etc.,
9. DeIiciencies on the part oI the banks viz. in credit appraisal, monitoring and Iollow-ups, delay in settlement oI
payments\ subsidiaries by government bodies etc.,
External factors:

1. Sluggish legal system -
4 Long legal tangles
4 Changes that had taken place in labour laws
4 Lack oI sincere eIIort.
2. Scarcity oI raw material, power and other resources.
3. Industrial recession.
4. Shortage oI raw material, raw material\input price escalation, power shortage, industrial recession, excess capac
natural calamities like Iloods, accidents.
5. Failures, non payment\ over dues in other countries, recession in other countries, externalization problems, adve
exchange rates etc.
6. Government policies like excise duty changes, Import duty changes etc.,

Gross NPAs sector wise as on March 2001
(Table 2)
Borrowing segment wise distribution of NPAs Amount Rs. in
crores
Percentage of
Total NPAs
Public Sector Units 1334.05 2.4
Large industries 11498.7 20.99
Medium Industries 8658.69 15.81
Other non-priority sectors 9516.62 17.37
Agriculture 7311.4 13.34
Small Scale Industries 10284.98 18.78
Other Priority Sectors 6169.3 11.72
(Source: RBI website)


Conclusion Regarding Contributory Reasons
The study oI about 900 top NPA accounts in 27 public sector banks that has been tabulated Irom the available
inIormation revealed by RBI, that the Iollowing are the important Iactors Ior units becoming sick/weak and
constantly accounts turning NPA in the order oI prominence:

* DiversiIication oI Iunds (No. 7 above Internal Iactor), mostly Ior expansion \diversiIication \ modernization,
taking up oI new projects, is the single most prominent reason. Besides being so, this Iactor also has signiIicant
proportion oI cases, when compared to other Iactors.

* Internal Iactor (No. 6 above), Iailure oI business (product), ineIIicient management, inappropriate technology,
product obsolescence.

* External Iactor (No. 3 above), comprising industrial recession, price escalation, power shortage, accidents etc.,

* Time \ cost overrun during the project implementation stage leading to liquidity strain and turning NPA into nex
Iactor (No. 2 above Internal Iactor).

* Other Iactors in order or prominence are Government Policies like changes in Import \ Excise duties etc., (No 5
above External Iactor), willIul deIault, Iraud \ misappropriation, disputes etc., (No. 8 above Internal Iactor) and
lastly, deIiciencies on the part oI banks delays in release oI limits and delay in settlement oI payments by governm
bodies (No. 6 above External Iactor).
(Exhibit - 1)
Causes for an Account becoming NPA
Those Attributable
to Borrower
Causes Attributable
to Banks
Other Causes
a) Failure to bring in Required capital
b) Too ambitious project
c) Longer gestation period
d) Unwanted Expenses
e) Over trading
I) Imbalances oI inventories
g) Lack oI proper planning
h) Dependence on single customers
i) Lack oI expertise
j) Improper working Capital Mgmt.
k) Mis management
a) Wrong selection oI borrower
b) Poor Credit appraisal
c) UnhelpIul in supervision
d) Tough stand on issues
e) Too inIlexible attitude
I) Systems overloaded
g) Non inspection oI Units
h) Lack oI motivation
i) Delay in sanction
j) Lack oI trained staII
k) Lack oI delegation oI work
a) Lack oI InIrastructure
b) Fast changing technolo
c) Un helpIul attitude oI
Government
d) Changes in consumer
preIerences
e) Increase in material cos
I) Government policies
g) Credit policies
h) Taxation laws
i) Civil commotion
l) Diversion oI Funds
m) Poor Quality Management
n) Heavy borrowings
o) Poor Credit Collection
p) Lack oI Quality Control
l) Sudden credit squeeze by
banks
m) Lack oI commitment to
recovery
n) Lack oI technical, personnel
& zeal to
j) Political hostility
k) Sluggish legal system
l) Changes related to
Banking amendment Act

Projection of NPAs over next three years in public sector Banks
The paper Iocuses on projecting the Non PerIorming Assets oI Public Sector Banks over next three years. The
method used Ior this study is "Trend Analysis Three year Moving Average Method."
The study Iocused on measuring the Trend Ior Iour aspects:

1. Gross NPAs to Gross Advances
2. Gross NPAs to Total Advances
3. Net NPAs to Net Advances
4. Net NPAs to Total Advances

The Iormula used Ior "Three year Moving Average" is:
Abc , bcd , cde , deI , ...
3 3 3 3

This is one oI the Ilexible methods oI measuring the trend. While applying this method, it is necessary to select a
period Ior moving average appropriately depending upon the availability oI the data. In this case the data available
was ten years and hence the Three-year moving average Iound to be suitable Ior projecting the Iuture trend.
Assumptions
While measuring the Iuture trend oI NPAs Ior next three years in public sector banks, the Iollowing are the key
issues, which are assumed to be constant.

* It is to be noted that the norms Ior recognizing NPAs are changing every year. Previously it was Iour quarters, th
it was made to three quarters and now Irom come 2004 it will be only one quarter.

* For commercial Banks the Capital Adequacy Norms are been prescribed recently, which were not mentioned in
early 90's.

* Norms regarding Provisions have changed over the last decade.

* Income Recognition norms were introduced in mid 90's.

* According to Basel committee Prudential Norms were introduced.

* Asset Liability Management Guidelines is expected to be issued by RBI.
1. Gross NPAs to Gross Advances:
(Table-3)

Year Gross NPAs / Gross
Advances
Trend Line
1. 1992-93 23.2 -
2. 1993-94 24.8 22.5
3. 1994-95 19.5 20.8
4. 1995-96 18.0 18.43
5. 1996-97 17.8 17.26
6. 1997-98 16.0 16.56
7. 1998-99 15.9 15.33
8. 1999-00 14.0 14.1
9. 2000-01 12.4 12.5
10. 2001-02 11.1 -

(Graph 1)

Note: Series 1: Gross NPAs to Gross Advances
Series 2: Trend Line
Analysis
During the year 1992-93 to 2001-02, there has been a sharp decline in Gross NPAs to Gross Advances. The Trend
Line also shows a continues decreasing trend. From this, it can be concluded that over the next three years (i.e 200
03 to 2004-05), Gross NPAs to Gross Advances oI public sector banks would decrease.

2. Gross NPAs to Total Advances:
(Table 4)
Year Gross NPAs / Total
Advances
Trend Line
1. 1992-93 11.8 -
2. 1993-94 10.8 10.43
3. 1994-95 8.7 9.23
4. 1995-96 8.2 8.23
5. 1996-97 7.8 7.66
6. 1997-98 7.0 7.16
7. 1998-99 6.7 6.56
8. 1999-00 6.0 6.00
9. 2000-01 5.3 5.4
10. 2001-02 4.9 -

(Chart 2)

Note: Series 1: Gross NPAs to Total Advances
Series 2: Trend Line
Analysis
During the year 1992-93 to 2001-02 , there has been considerable decline in GNPAs to Total Assets. The Trend L
too says the same story. ThereIore the GNPAs to Total Assets oI public sector banks will decline in the next three
years to come (i.e 2002-03 to 2004-05).

3. Net NPAs to Net Advances:
(Table 5)
Year Net NPAs / Net
Advances
Trend Line
1. 1992-93 11.3 -
2. 1993-94 12.87 11.62
3. 1994-95 10.7 10.82
4. 1995-96 8.9 9.6
5. 1996-97 9.2 8.76
6. 1997-98 8.2 8.5
7. 1998-99 8.1 7.9
8. 1999-00 7.4 7.4
9. 2000-01 6.7 6.63
10. 2001-02 5.8 -

(Chart 3)

Note: Series - 1: Net NPAs to Net Advances
Series 2: Trend Line
Analysis
During the year 1992-93 to 2001-02, there has been a steady and considerable decrease in percentage oI Net NPAs
Net Advances. The Trend Line also shows that there is a decreasing trend and Net NPAs over next three years (i.e
2002-03 to 2004-05) would decrease considerably.

4. Net NPAs to Total Assets:
(Table 6)
Year Net NPAs /
Total Assets
Trend Line
1. 1992-93 4.6 -
2. 1993-94 5.1 4.56
3. 1994-95 4 4.23
4. 1995-96 3.6 3.76
5. 1996-97 3.7 3.53
6. 1997-98 3.3 3.36
7. 1998-99 3.1 3.1
8. 1999-00 2.9 2.9
9. 2000-01 2.7 2.66
10. 2001-02 2.4 -

(Chart 4)

Note: Series -1: Net NPAs to Total Assets
Series 2: Trend Line
Analysis
During the year 1992-93 to 2001-02, there has been a marginal decline in Net NPAs to Total Assets. The Trend Li
shows that there has been a steady decline and it can be inIerred that over next three years (i.e 2002-03 to 2004-05
Net NPAs to Total Assets oI public sector banks would decrease but at a marginal rate.
Final Analysis
The Iuture picture oI Commercial banks more so the public sector banks seem to be rosy. As the Trend Line sugge
that the NPAs oI public sector banks will decline marginally both in terms oI Gross and Net Iigures over next thre
years. This may be due to higher provisions, which the public sector banks have been providing. The real issue to
identiIied is though the NPAs, as a percentage seems to be declining over the years but the absolute Iigures seems
be increasing. In this vein it would be interesting to see the NPAs both in terms oI absolute Iigures and in terms oI
percentage oI public sector banks in the coming three years.
Concluding Remarks
A strong banking sector is important Ior a Ilourishing economy. The Iailure oI the banking sector may have an
adverse impact on other sectors.
Over the years, much has been talked about NPAs and the emphasis so Iar has been only on identiIication and
quantiIication oI NPAs rather than on ways to reduce and upgrade them.
There is also a general perception that the prescription oI 40 oI net bank credit to priority sectors have led to hig
NPAs, due to credit to these sectors becoming sticky. Managers oI rural and semi-urban branches generally sanctio
these loans. In the changed context oI new prudential norms and emphasis on quality lending and proIitability,
managers should make it amply clear to potential borrowers that banks resources are scarce and these are meant to
Iinance viable ventures so that these are repaid on time and relevant to other needy borrowers Ior improving the
economic lot oI maximum number oI households. Hence, selection oI right borrowers, viable economic activity,
adequate Iinance and timely disbursement, correct end use oI Iunds and timely recovery oI loans is absolutely
necessary pre conditions Ior preventing or minimizing the incidence oI new NPAs.

However, banks are yet another sector where the rot has already set in!..
It is high time to take stringent measures to curb NPAs and see to it that the
Non-Performing Assets may not turn banks into Non-Performing Banks; instead steps should be taken to covert N
Performing Assets into Now-Performing Assets.

It's now or never
REFERENCES

1. Alok Majumdar, NPAs : Recovery Blues, Treasury Management (Dec.2000) pp. 46-49.
2. Special Report: NPAs Grossly Mis-understood, Business India (Feb. 1999) pp. 60-62.
3. M.S.A. Rao, A Better Future Ior Banks, Indian Management (july 2001) pp. 1 4-16.
4. Vasanth C. Joshi & Vinay V. Joshi, Managing Indian Banks Challenges ahead.
5. M.Y. Khan, How to Tackle Credit DeIaults, Business Line (Feb. 2000) pp 6.
6. K. Kannan, CMD, Bank oI Baroda, Whose NPAs is it anyway, The Agenda, Economic Times & CMIE special
presentation copy (Dec. 2000) pp. 45-46
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8. Some Aspects & Issues relating to NPAs in Commercial Banks, RBI : Study, RBI Publications (July 1999).
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10. Pramita Mukherjee, Dealing with NPAs: Lessons Irom International Experiences, ICRA bulletin Money &
Finance, (Jan-Mar. 2003), pp. 64 69.
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