INTRODUCTION TO BANKING INDUSTRY:

The Indian Banking industry, which is governed by the Banking Regulation Act of India, 1949
can be broadly classified into two major Categories, non-scheduled banks and scheduled banks.
Scheduled banks Comprise commercial banks and the co-operative banks. In terms of
Ownership, commercial banks can be further grouped into nationalized Banks, the State Bank of
India and its group banks, regional rural banks and private sector banks (the old/ new domestic
and foreign). These Banks have over 67,000 branches spread across the country in every city and
villages of all nook and corners of the land. The first phase of financial reforms resulted in the
nationalization of 14 major Banks in 1969 and resulted in a shift from Class banking to Mass
Banking. This in turn resulted in a significant growth in the geographical Coverage of banks.
Every bank had to earmark a minimum percentage of their loan portfolio to sectors identified as
“priority sectors”. The Manufacturing sector also grew during the 1970s in protected environs
the banking sector was a critical source. The next wave of reforms saw the nationalization of 6
more commercial banks in 1980. Since then the number of scheduled commercial banks
increased four-fold and the number of bank branches increased eight-fold. And that was not the
limit of growth. After the second phase of financial sector reforms and liberalization of the sector
in the early nineties, the Public Sector Banks (PSB) s found it extremely difficult to compete
with the new private sector banks and the foreign banks. The new private sector banks first made
their appearance after the guidelines permitting them were issued in January 1993. Eight New
private sector banks are presently in operation. These banks due to their late start has access to
state-of-the-art technology, which in turn helps them to save on manpower costs. During the year
2000, the State Bank of India (SBI) and its 7 associates accounted for a 25 percent share in
deposits and 28.1 percent share in Credit. The 20 nationalized banks accounted for 53.2 percent
of the deposits and 47.5 percent of credit during the same period. The share of foreign banks
(numbering 42), regional rural banks and other scheduled Commercial banks accounted for 5.7
percent, 3.9 percent and 12.2 percent respectively in deposits and 8.41 percent, 3.14 percent and
B12.85 percent respectively in credit during the year 2000.about the detail Of the current
scenario we will go through the trends in modern economy Of the country.
Current Scenario:

The industry is currently in a transition phase. On the one hand, the PSBs, which are the
mainstay of the Indian Banking system are in the process of shedding their flab in terms of
excessive manpower, excessive Non Performing Assets (NPAs) and excessive governmental
equity, while on the other hand the private sector banks are consolidating themselves through
mergers and acquisitions. PSBs, which currently account for more than 78 percent of total
banking industry assets are saddled with NPAs (a mindboggling Rs 830 billion in 2000), falling
revenues from traditional sources, lack of modern technology and a massive workforce while the
new private sector banks are forging ahead and rewriting the traditional banking business model
by way of their sheer innovation and service. The PSBs are of course currently working out
challenging strategies even as 20 percent of their massive employee strength has dwindled in the
wake of the successful Voluntary Retirement Schemes (VRS) schemes. The private players
however cannot match the PSB’s great reach, great size and access to low cost deposits.
Therefore one of the means for them to combat the PSBs has been through the merger and
acquisition (M& A) route. Over the last two years, the industry has witnessed several such
instances. For instance, HDFC Bank’s merger with Times Bank Icici Bank’s acquisition of ITC
Classic, Anagram Finance and Bank of Madurai. Centurion Bank, Indusind Bank, Bank of
Punjab, Vysya Bank are said to be on the lookout. The UTI bank- Global Trust Bank merger
however opened a Pandora ’s Box and brought about the realization that all was not well in the
functioning of many of the private sector banks. Private sector Banks have pioneered internet
banking, phone banking, anywhere banking, mobile banking, debit cards, Automatic Teller
Machines (ATMs) and combined various other services and integrated them into the mainstream
banking arena, while the PSBs are still grappling with disgruntled employees in the aftermath of
successful VRS schemes. Also, following India’s commitment to the W To agreement in LTD.
respect of the services sector, foreign banks, including both new and the existing ones, have been
permitted to open up to 12 branches a year with effect from 1998-99 as against the earlier
stipulation of 8 branches.Tasks of government diluting their equity from 51 percent to 33 percent
in November 2000 has also opened up a new opportunity for the takeover of even the PSBs. The
FDI rules being more rationalized in Q1FY02 may also pave the way for foreign banks taking
the M& A route to acquire willing Indian partners. Meanwhile the economic and corporate sector
slowdown has led to an increasing number of banks focusing on the retail segment. Many of
them are also entering the new vistas of Insurance. Banks with their phenomenal reach and a
regular interface with the retail investor are the best placed to enter into the insurance sector.
Banks in India have been allowed to provide fee-based insurance services without risk
participation, invest in an insurance company for providing infrastructure and services support
and set up of a separate joint venture insurance company with risk participation.
 INTRODUCTION TO UNITED BANK AND ITS MANAGEMENT

United Bank of India (UBI) (BSE: 533171) is a state-owned financial services company

headquartered in Kolkata, India. Presently the bank has a three-tier organizational setup
consisting of its Head office in Kolkata, 28 Regional offices and 1453 branches spread all over
India. However, its major presence is in eastern India. Due to a common acronym (UBI), which
it shares with Union Bank of India, which also has an all-India presence, the public sometimes
confuses the two banks.

On March 30, 2009, the Indian government decided to approve the restructuring United Bank of
India. The cabinet has approved the government's proposal to investing 2.50 billion rupees in
shares by March 31, and another 5.50 billion in the next fiscal year in Tier-I capital instruments.
The move is part of the Indian government's program to improve the capital base of the state-
owned banks.

History:

UBI was the result of the merger in 1950 of four Bengali banks: Comilla Banking
Corporation (founded by Narendra Chandra Datta in 1914 in what is now Bangladesh), Bengal
Central Bank (founded by Sri J.C. Das in 1918), Comilla Union Bank (founded by Sri L.B.
Dutta in 1922) and Hooghly Bank(founded by Sri D.N. Mukherjeee 1932).

 1961 UBI merged in Cuttack Bank and Tezpur Industrial Bank.

 1969 On 19 July, the Government of India nationalized UBI, along with 13 other major

Indian commercial banks. At the time of nationalization UBI had only 174 branches.

 1973 UBI acquired Hindusthan Mercantile Bank.

 1976 UBI acquired Narang Bank of India

ABSTRACT 
A strong banking sector is important for flourishing economy. The failure of the banking sector
may have an adverse impact on other sectors. Non-performing assets are one of the major
concerns for banks in India.  NPAs reflect the performance of banks. A high level of NPAs
suggests high probability of a large number of credit defaults that affect the profitability and net-
worth of banks and also erodes the value of the asset. The NPA growth involves the necessity of
provisions, which reduces the overall profits and shareholders value. 

The issue of Non Performing Assets has been discussed at length for financial system all over the
world. The problem of NPAs is not only affecting the banks but also the whole economy. In fact
high level of NPAs in Indian banks is nothing but a reflection of the state of health of the
industry and trade.

The paper deals with understanding the concept of NPAs, its magnitude and major causes for an
account becoming non-performing, projection of NPAs over next three years in Public sector
banks and concluding remarks. 

NON PERFORMING ASSET

NPA. The three letters Strike terror in banking sector and

business circle today. NPA is short form of “Non Performing

Asset”. The dreaded NPA rule says simply this: when interest

or other due to a bank remains unpaid for more than 90 days,

the entire bank loan automatically turns a non performing

asset. The recovery of loan has always been problem for banks

and financial institution. To come out of these first we need to

think is it possible to avoid NPA, no cannot be then left is to

look after the factor responsible for it and managing those

factors.
2.1 Definitions:

An asset, including a leased asset, becomes nonperforming

when it ceases to generate income for the bank.

A ‘non-performing asset’ (NPA) was defined as a credit facility

in respect of which the interest and/ or instalment of principal

has remained ‘past due’ for a specified period of time.

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 NPAs,

from the year ending March 31, 2004. Accordingly, with effect

from March 31, 2004, a non-performing asset (NPA) shall be a

loan or an advance where;

 Interest and/ or instalment of principal remain overdue for

a period of more than 90 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

(OD/CC),

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 The bill remains overdue for a period of more than 90

days in the case of bills purchased and discounted,

 Interest and/or instalment of principal remains overdue

for two harvest seasons but for a period not exceeding two

half years in the case of an advance granted for agricultural

purposes.

As a facilitating measure for smooth transition to 90 days

norm, banks have been advised to move over to charging of

interest at monthly rests, by April 1, 2002. However, the date

of classification of an advance as NPA should not be changed

on account of charging of interest at monthly rests. Banks

should, therefore, continue to classify an account as NPA only

if the interest charged during any quarter is not serviced fully

within 180 days from the end of the quarter with effect from

April 1, 2002 and 90 days from the end of the quarter with

effect from March 31, 2004.

2.2 NPAs: AN ISSUE FOR BANKS AND FIs IN INDIA

To start with, performance in terms of profitability is a

benchmark for any business enterprise including the banking

industry. However, increasing NPAs have a direct impact on

banks profitability as legally banks are not allowed to book

income on such accounts and at the sometime are forced to

make provision on such assets as per the Reserve Bank of

India (RBI) guidelines. Also, with increasing deposits made by

the public in the banking system, the banking industry cannot

afford defaults by borrower s since NPAs affects the repayment

capacity of banks.

Further, Reserve Bank of India (RBI) successfully creates

excess liquidity in the system through various rate cuts and

banks fail to utilize this benefit to its advantage due to the tear

of burgeoning non-performing assets.

2.3 INDIAN ECONOMY AND NPAs

Undoubtedly the world economy has slowed down, recession is

at its peak, globally stock markets have tumbled and business

itself is getting hard to do. The Indian economy has been much

affected due to high fiscal deficit, poor infrastructure facilities,

sticky legal system, cutting of exposures to emerging markets

by FIs, etc.

16

Further, international rating agencies like, Standard & Poor

have lowered India’s credit rating to sub-investment grade.

Such negative aspects have often outweighed positives such

as increasing forex reserves and a manageable inflation rate.

Under such a situation, it goes without saying that banks are

no exception and are bound to face the heat of a global

downturn. One would be surprised to know that the banks and

financial institution in India hold nonperforming assets worth

Rs. 110000 crores Bankers have realized that unless the level

of NPAs is reduced drastically, they will find it difficult to

survive.

2.4 GLOBAL DEVELOPMENTS AND NPAs

The core banking business is of mobilizing the deposits and

utilizing it for lending to industry. Lending business is generally

encouraged because it has the effect of funds being

transferred from the system to productive purposes, which

results into economic growth.

However lending also carries credit risk, which arises from the

failure of borrower to fulfill its contractual obligations either

during the course of a transaction or on a future obligation.

A question that arises is how much risk can a bank afford to

take? Recent happenings in the business world -Enron,

WorldCom, Xerox, Global Crossing do not give much

confidence to banks. In case after case, these giant corporate

becan1e bankrupt and failed to provide investors with clearer

and more complete information thereby introducing a degree

of risk that many investors could neither anticipate nor

welcome. The history of financial institutions also reveals the

fact that the biggest banking failures were due to credit risk.

Due to this, banks are restricting their lending operations to

secured avenues only with adequate collateral on which to fall

back upon in a situation of default.

17

2.5 FACTORS FOR RISE IN NPAs

The banking sector has been facing the serious problems of

the rising NPAs. But the problem of NPAs is more in public

sector banks when compared to private sector banks and

foreign banks. The NPAs in PSB are growing due to external as

well as internal factors.

2.5.1 EXTERNAL FACTORS:-

Ineffective recovery tribunal

The Govt. has set of numbers of recovery tribunals, which

works for recovery of loans and advances. Due to their

negligence and ineffectiveness in their work the bank

suffers the consequence of non-recover, thereby reducing

their profitability and liquidity.

Willful Defaults

18
There are borrowers who are able to pay back loans but

are intentionally withdrawing it. These groups of people

should be identified and proper measures should be taken

in order to get back the money extended to them as

advances and loans.

Natural calamities

This is the measure factor, which is creating alarming rise

in NPAs of the PSBs. every now and then India is hit by

major natural calamities thus making the borrowers

unable to pay back there loans. Thus the bank has to

make large amount of provisions in order to compensate

those loans, hence end up the fiscal with a reduced profit.

Mainly ours farmers depends on rain fall for

cropping. Due to irregularities of rain fall the farmers are

not to achieve the production level thus they are not

repaying the loans.

Industrial sickness

Improper project handling , ineffective management ,

lack of adequate resources , lack of advance technology ,

day to day changing govt. Policies give birth to industrial

sickness. Hence the banks that finance those industries

ultimately end up with a low recovery of their loans

reducing their profit and liquidity.

Lack of demand

Entrepreneurs in India could not foresee their product

demand and starts production which ultimately piles up

their product thus making them unable to pay back the

money they borrow to operate these activities. The banks

recover the amount by selling of their assets, which covers a

minimum label. Thus the banks record the non-recovered part as NPAs and

has to make provision for it.

 Change on Govt. policies

With every new govt. banking sector gets new policies for its operation. Thus

it has to cope with the changing principles and policies for the regulation of

the rising of NPAs.

The fallout of handloom sector is continuing as most of the weavers

Co-operative societies have become defunct largely due to withdrawal of

19

state patronage. The rehabilitation plan worked out by the Central

government to revive the handloom sector has not yet been implemented.

So the over dues due to the handloom sectors are becoming NPAs.

2.5.2 INTERNAL FACTORS:-

 Defective Lending process

There are three cardinal principles of bank lending that

have been followed by the commercial banks since long.

i. Principles of safety

ii. Principle of liquidity

iii. Principles of profitability

i. Principles of safety :-

By safety it means that the borrower is in a position to

repay the loan both principal and interest. The

repayment of loan depends upon the borrowers: a)

Capacity to pay b) Willingness to pay

a) Capacity to pay depends upon:

1. Tangible assets

2. Success in business

b) Willingness to pay depends on:

1. Character

2. Honest

3. Reputation of borrower

The banker should, therefore take utmost care in

ensuring that the enterprise or business for which a loan

is sought is a sound one and the borrower is capable of

carrying it out successfully .He should be a person of

integrity and good character.

 Inappropriate technology

Due to inappropriate technology and management

information system, market driven decisions on real time

basis cannot be taken. Proper MIS and financial

accounting system is not implemented in the banks,

which leads to poor credit collection, thus NPA. All the

branches of the bank should be computerized.

20

 Improper SWOT analysis

The improper strength, weakness, opportunity and threat

analysis is another reason for rise in NPAs. While

providing unsecured advances the banks depend more on

the honesty, integrity, and financial soundness and credit

worthiness of the borrower.

•Banks should consider the borrowers own capita l

investment.

•it should collect credit information of the borrowers

from_

a. From bankers.
b. Enquiry from market/segment of trade, industry,

business.

c. From external credit rating agencies.

•Analyze the balance sheet .

True picture of business will be revealed on analysis

of profit/loss a/c and balance sheet.

•Purpose of the loan

When bankers give loan, he should analyze the

purpose of the loan. To ensure safety and liquidity,

banks should grant loan for productive purpose only.

Bank should analyze the profitability, viability, long

term acceptability of the project while financing.

 Poor credit appraisal system

Poor credit appraisal is another factor for the rise in NPAs.

Due to poor credit appraisal the bank gives advances to

those who are not able to repay it back. They should use

good credit appraisal to decrease the NPAs.

 Managerial deficiencies

The banker should always select the borrower very

carefully and should take tangible assets as security to

safe guard its interests. When accepting securities banks

should consider the_

1. Marketability

2. Acceptability

21

3. Safety

4. Transferability.

The banker should follow the principle of

diversification of risk based on the famous maxim “do not

keep all the eggs in one basket”; it means that the banker

should not grant advances to a few big farms only or to

concentrate them in few industries or in a few cities. If a

new big customer meets misfortune or certain traders or

industries affected adversely, the overall position of the

bank will not be affected.

Like OSCB suffered loss due to the OTM Cuttack, and

Orissa hand loom industries. The biggest defaulters of

OSCB are the OTM (117.77lakhs), and the handloom

sector Orissa hand loom WCS ltd (2439.60lakhs).

 Absence of regular industrial visit

The irregularities in spot visit also increases the NPAs.

Absence of regularly visit of bank officials to the customer

point decreases the collection of interest and principals

on the loan. The NPAs due to willful defaulters can be

collected by regular visits.

 Re loaning process

Non remittance of recoveries to higher financing agencies

and re loaning of the same have already affected the

smooth operation of the credit cycle. Due to re loaning to

the defaulters and CCBs and PACs, the NPAs of OSCB is

increasing day by day.

2.6 PROBLEMS DUE TO NPA

1. Owners do not receive a market return on their capital .in

the worst case, if the banks fails, owners lose their assets.

22

In modern times this may affect a broad pool of

shareholders.

2. Depositors do not receive a market return on saving. In

the worst case if the bank fails, depositors lose their

assets or uninsured balance.

3. Banks redistribute losses to other borrowers by charging

higher interest rates, lower deposit rates and higher

lending rates repress saving and financial market, which

hamper economic growth.

4. Nonperforming loans epitomize bad investment. They

misallocate credit from good projects, which do not

receive funding, to failed projects. Bad investment ends

up in misallocation of capital, and by extension, labor and

natural resources.

Nonperforming asset may spill over the banking system and

contract the money stock, which may lead to economic

contraction. This spillover effect can channelize through

liquidity or bank insolvency:

a) When many borrowers fail to pay interest, banks may

experience liquidity shortage. This can jam payment across

the country.

b) Illiquidity constraints bank in paying depositors

c) Undercapitalized banks exceed the bank’s capital base.

'Out of Order' status :

An account should be treated as 'out of order' if

the outstanding balance remains continuously in excess of the

sanctioned limit/drawing power. In cases where the

outstanding balance in the principal operating account is less

than the sanctioned limit/drawing power, but there are no

credits continuously for six months as on the date of Balance

Sheet or credits are not enough to cover the interest debited

during the same period, these accounts should be treated as

'out of order'.

‘ Overdue’:

Any amount due to the bank under any credit

facility is ‘overdue’ if it is not paid on the due date fixed by the

bank.23
CAUSES FOR NON-PERFORMING ASSETS IN PUBLIC SECTOR BANKS
Introduction

Granting of credit for economic activities is the prime duty of banking. Apart from raising
resources through fresh deposits, borrowings and recycling of funds received back from
borrowers constitute a major part of funding credit dispensation activity. Lending is generally
encouraged because it has the effect of funds being transferred from the system to productive
purposes, which results into economic growth. However lending also carries a risk called credit
risk, which arises from the failure of borrower. Non-recovery of loans along with interest forms a
major hurdle in the process of credit cycle. Thus, these loan losses affect the banks profitability
on a large scale. Though complete elimination of such losses is not possible, but banks can
always aim to keep the losses at a low level.

Non-performing Asset (NPA) has emerged since over a decade as an alarming threat to the
banking industry in our country sending distressing signals on the sustainability and endurability
of the affected banks. The positive results of the chain of measures affected under banking
reforms by the Government of India and RBI in terms of the two Narasimhan Committee
Reports in this contemporary period have been neutralized by the ill effects of this surging threat.
Despite various correctional steps administered to solve and end this problem, concrete results
are eluding. It is a sweeping and all pervasive virus confronted universally on banking and
financial institutions. The severity of the problem is however acutely suffered by Nationalised
Banks, followed by the SBI group, and the all India Financial Institutions.

Objectives of the study:

i. To understand the meaning & nature of NPAs.

ii. To examine the causes for NPAs in public sector banks.

iii. To project the NPAs in public sector banks over next three years using Trend Analysis as
tool.
Methodology:

In order to meet the Third objective, the method of Moving Averages is been used, from which
we arrive at a Trend Analysis. While the rationale behind selection of 'Three year Moving
Average' method is because of the availability of the data. The data available was from the ten
years and needless to say that for such a data a 'Six year 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 the 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 becomes 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 having
performing status.

Though the term NPA connotes a financial asset of a commercial bank, which has stopped
earning an expected reasonable return, it is also a reflection of the productivity of the unit, firm,
concern, industry and nation where that asset is idling. Viewed with this perspective, the NPA is
a result of an environment that prevents it from performing up to expected levels.

The definition of NPAs in Indian context is certainly more liberal with two quarters norm being
applied for classification of such assets. The RBI is moving over to one-quarter norm from 2004
onwards.

Magnitude of NPAs:

In India, the NPAs that are considered to be at higher levels than those in other countries have of
late, attracted the attention of public. The Indian banking system had acquired a large quantum of
NPAs, which can be termed as legacy NPAs.
Dealing with NPAs involves two sets of policies

1.Relating to existing NPAs

2. To reduce fresh NPA generation.

As far as old NPAs are concerned, a bank can remove it on its own or sell the assets to AMCs to
clean up its balance sheet. For preventing fresh NPAs, the bank itself should adopt proper
policies.

Causes for Non Performing Assets :

A strong banking sector is important for a flourishing economy. The failure of the banking sector
may have an adverse impact on other sectors. The Indian banking system, which was operating
in a closed economy, now faces the challenges of an open economy.

On one hand a protected environment ensured that banks never needed to develop sophisticated
treasury operations and Asset Liability Management skills.

On the other hand a combination of directed lending and social banking relegated profitability
and competitiveness to the background. The net result was unsustainable NPAs and consequently
a higher effective cost of banking services.

One of the main causes of NPAs into banking sector is the directed loans system under which
commercial banks are required a prescribed percentage of their credit (40%) to priority sectors.
As of today nearly 7 percent of Gross NPAs are locked up in 'hard-core' doubtful and loss assets,
accumulated over the years. The problem India Faces is not lack of strict prudential norms but

i. The legal impediments and time consuming nature of asset disposal proposal.

ii. Postponement of problem in order to show higher earnings.

iii. Manipulation of debtors using political influence.

Macro Perspective Behind NPAs:

A lot of practical problems have been found in Indian banks, especially in public sector banks.
For Example, the government of India had given a massive wavier of Rs. 15,000 Crs. under the
Prime Minister ship of Mr. V.P. Singh, for rural debt during 1989-90. This was not a unique
incident in India and left a negative impression on the payer of the loan.

Poverty elevation programs like IRDP, RREP, SUME, SEPUP, JRY, PMRY etc., failed on
various grounds in meeting their objectives. The huge amounts of loan granted under these
schemes were totally unrecoverable by banks due to political manipulation, misuse of funds and
non-reliability of target audience of these sections. Loans given by banks are their assets and as
the repayment of several of the loans were poor, the quality of these assets were steadily
deteriorating. Credit allocation became 'Loan Melas', loan proposal evaluations were slack and as
a result repayment were very poor.

There are several reasons for an account becoming NPA.

* Internal factors

* External factors

Internal factors:

• Funds borrowed for a particular purpose but not use for the said purpose.

• Project not completed in time.

• Poor recovery of receivables.

• Excess capacities created on non-economic costs.

• In-ability of the corporate to raise capital through the issue of equity or other debt
instrument from capital markets.
• Business failures.

• Diversion of funds for expansion\modernization\setting up new projects\ helping or

promoting

• sister concerns.

• Willful defaults, siphoning of funds, fraud, disputes, management disputes, mis-

appropriation etc.,

• Deficiencies on the part of the banks viz. in credit appraisal, monitoring and follow-ups,

• Delay in settlement of payments\ subsidiaries by government bodies etc.,

External factors:

• Sluggish legal system - Long legal tangles Changes that had taken place in labour laws
Lack of sincere effort.

• Scarcity of raw material, power and other resources.

• Industrial recession.

• Shortage of raw material, raw material\input price escalation, power shortage, industrial
recession, excess capacity, natural calamities like floods, accidents.

• Failures, non payment\ over dues in other countries, recession in other countries,
externalization problems, adverse exchange rates etc.

• Government policies like excise duty changes, Import duty changes etc.,
2. Preventing NPAs:

2.1 At the pre-disbursement stage, appraisal techniques of bank need to be sharpened. All
technical, economic, commercial, organizational and financial aspects of the project need to be
assessed realistically. Bankers should satisfy themselves that the project is technically feasible
with reference to technical know how, scale of production etc. The project should be
commercially feasible in that all background linkages by way of availability of raw materials at
competitive rates and that all forward linkages by way of assured market are available. It should
be ensured assumptions on which the project report is based are realistic. Some projects are born
sick because of unrealistic planning, inadequate appraisal and faulty implementation. As the
initiative to sanction or reject the project proposal lies with the banker, he can exercise his
judgment judiciously. The banker should at the pre-sanction stage not only appraise the project
but also the promoter – his character and his capacity. It is said that it is more prudent to sanction
a 'B' class project with an 'A' class entrepreneur than vice-versa. He has to ensure that the
borrower complies with all the terms of sanction before disbursement.

2.2 A major cause for NPA is fixation of unrealistic repayment schedule. Repayment schedule
may be fixed taking into account gestation or moratorium period, harvesting season, income
generation, surplus available etc. If the repayment schedule is defective both with reference to
quantum of instalment and period of recovery, assets have a tendency to become NPA.

2.3 At the post-disbursement stage, bankers should ensure that the advance does not become and
NPA by proper follow-up and supervision to ensure both assets creation and asset utilisation.
Bankers can do either off-site surveillance or on site inspection to detect whether the unit /
project is likely to become NPA. Instead of waiting for the mandatory period before classifying
an asset as NPA, the banker should look for early warning signals of NPA.

2.4 The following are the sources from which the banker can detect signals, which need quick
remedial action:

1. a) Scrutiny of accounts and ledger cards – During a scrutiny of these, banker can be on
alert if there is persistent regularity in the account, or if there is any default in payment of interest
and instalment or when there is a downward trend in credit summations and frequent return of
cheques or bills,
2. b) Scrutiny of statements – If the scrutiny of the statements submitted by the borrower
reveal a sharp decline in production and sales, rising level of inventories, diversion of funds, the
banker should realise that all is not well with the unit.

3. c) External sources – The banker may know the state of the unit through external
sources. Recession in the industry, unsatisfactory market reports, unfavourable changes in
government policy and complaints from suppliers of raw material, may indicate that the unit is
not working as per schedule.

4. d) Computerisation of loan monitoring – In computerised branches, it is possible to

computerise the loan monitoring system so that accounts, which show signs of sickness or
weakness can be monitored more closely than other accounts.

2.5 Personal visit and face-to-face discussion – By inspecting the unit the banker is able to see
for himself where the problem lies - either production bottlenecks or income leakage or whether
it is a case of willful default. During discussion with the borrower, the banker may come to know
details relating to breakdown in plant and machinery, labour strike, change in management, death
of a key person, reconstitution of the firm, dispute among the partners etc. All these factors have
a bearing on the functioning of the unit and on its financial status.

2.6 ‘Special Mention’ category of accounts – Based on warning signals obtained through both
off-site and on-site monitoring, banks may classify accounts with irregularities persisting for
more than 30 days under ‘Special Mention’ or ‘Potential NPA’ category. This will help the bank
to initiate proactive remedial measures for early regularisation. The measures include timely
release of additional funds to borrowers with temporary liquidity problems and restructuring of
accounts of sincere and honest borrowers after considering cases on merit.

2.7 On going classification – Although classification of assets is a yearly exercise, banks would
do well to have a system of on going classification of assets and quarterly provisioning. This
helps in assessing provisioning requirements well in advance. All doubts regarding classification
should be settled internally and a system of fixing accountability for failure to comply with the
regulatory guidelines should be introduced.
2.8 Strategy for reducing provision – The extent of provision for doubtful asset is with reference
to secured and unsecured portion. Cent percent provision needs to be made for the unsecured
portion. If banks can ensure that the loan outstanding is fully secured by realisable security, the
quantum of provision to be made would be less. It takes one year for a sub standard asset to slip
into doubtful category. Therefore, as soon as an account is classified as substandard, the banker
must keep strict vigil over the security during the next one year because in the event of the
account being classified as doubtful, the lack of security would be too costly for the bank.

3. Reducing NPAs

3.1 Cash recovery – Banks, instead of organising a recovery drive based on overdues, must short
list those accounts, the recovery of which would provide impetus to the system in reducing the
pressure on profitability by reduced provisioning burden. Vigorous efforts need to be made for
recovery of critical amount (overdue interest and instalment) that can save an account from NPA
classification:

1. a) In case of a term loan, the banker gets 90 days after the date of default to take
appropriate action and to persuade the borrower to pay interest or instalment whichever is due.

2. b) In case of a cash credit account, the banker gets 90 days for ensuring that the
irregularity in the account is rectified.

3. c) In case of direct agricultural loans, the account is classified NPA only after two
crop seasons (from sowing to harvesting) from the due date in case of short duration loans and
one crop season from the due date in case of long duration loans.

3.2 Up gradation of assets – Once accounts become NPA, then bankers should take steps to up
grade them by recovering the entire overdues. Close follow-up will generally ensure success.

3.3 Compromise settlements – Wherever feasible, in case of chronic NPAs, banks can consider
entering into com8promise settlements with the borrowers.

3.4 Recovery through legal recourse – Since provision amount progressively increases with
increase in time, it is necessary to take steps to recover dues either through persuasion or by legal
recourse. A strategy of fixing a dead line for recovery may force the bank to either recover or
shed the asset off the balance sheet. Banks may file suits promptly against wilful defaulters.
Banks can take recourse under either a civil suit or the Special Recovery Acts passed by various
states or the Securitisation and Reconstruction of Financial Assets and Enforcement of Security
Interest (SARFAESI) Act, 2002. The bank should vigorously follow up the legal cases.