Reduction of NAPAs - Key to Banking Reforms by Chander Shekhar *

Economic Reforms initiated in 1991 by the then Finance Minister, Dr. Manmohan Singh would have remained incomplete without the overhaul of the Indian Banking Sector. The process, which began on the basis of recommendations of the Narasimhamam Committee Report (first report) is still continuing, though many of the sick banks have been able to come out of the red after repeat doses of fund infusion. A few of the them, however, are still in the red but the efforts are on to resuscitate them. However, the bigger challenge at the moment is to deal with the worsening financial health of the financial institutions. The other important financial institution IDBI is also not in the pink of health and needs government support for revitalising itself.

The other aspect of the banking sector reforms relates to liberalisation of norms and guidelines for making the whole sector vibrant and competitive.

This was a gradual process undertaken with utmost care least it should disrupt the banking sector. Slowly, the Reserve Bank of India (RBI) freed interest rates, both on the deposit and the lending sides. At the same time it relaxed the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) unlocking more and more funds. On the deposit side, a bank is free to offer any rate depending upon its asset-liability position. Only savings rate are mandated by the RBI. Similarly, banks can charge any rate on lending operations depending on risk perception. It would be wrong to say that there are no controls, but they are much less as compared to the controls that existed before the initiation of the banking sector reforms.

Reduction of NPAs

The third and the most important dimension of the banking sector reforms was reduction of the non-performing assets (NPAs). In fact the whole effort to reform the banking sector would collapse if the banks are not able to contain and reduce their NPAs. It would be impossible for a bank with high NPAs to be either vibrant or competitive. What are these NPAs? These are the assets that do not yield any return. It is like owning a vast field where nothing grows, though the field was purchased at high rates.

Technically, NPAs consist of three categories of assets - sub-standard, doubtful and loss. As per the new norms for recognition, identification and classification of assets (changed with effect from March 31, 2001), assets classified as NPAs for a period upto two years belong to sub-standard category, while doubtful assets are those that remain NPAs for a period beyond two years. Loss assets are those which are identified as such either by banks themselves or internal/ external auditors or RBI but not written off.

According to the Economic Survey (2002-2003) gross NPAs of the public sector banks were of the order of Rs.56,507 crore at the end of 2001-2002. Private sector banks had gross NPAs of Rs.11,672 crore and foreign banks Rs.2,726 crore. Total gross NPAs of the banking sector amounted to Rs.70,905 crore.

This was 10.4 percent of gross advances of the banking sector. This means that banking sector does not earn any return on an investment of Rs.70,905 crore. The strategy of the successive finance ministers have been to fight this menace of growing NPAs. These efforts are yielding fruits. Gross NPAs as a percentage of gross advances were 12.7 percent in 1999-2000. It came down to 11.4 percent in 2000-2001 and 10.4 percent in 2001-2002. Similarly, net NPAs as percentage of net advances for the banking sector came down from 6.8 percent in 1999-2000 to 6.2 percent in 2000-2001 and 5.5 percent in 2001-2002. The banking sector reforms are on the right track, though not many are happy with the pace of reduction of NPAs.

Weak and Strong Banks

The Narasimhamam Committee suggested recapitalisation of a host of public sector banks. These banks were expected to follow prudential norms with regard to asset classification. The Narasimhamam Committee-II revisited the banking sector reforms to carry forward the unfinished agenda. It defined a weak bank as one whose accumulated losses and net NPAs exceed its net worth or whose operating profits less income on recapitalisation bonds was negative for three consecutive years. Then came the working group on restructuring weak public sector banks headed by former State Bank of India, Chairma, Shri M.S. Verma. The group identified seven parameters for identification of weak banks - CAR and Coverage Ratio under solvency; return on assets and net interest margin under earning capacity; and three ratios under profitability which include operating profit to average working funds, costs to income and staff cost to net interest income plus all other income. By and large the exercise, spread over a decade, achieved its objective to a large extent with many public sector banks being able to show results. At the end of March, 2002, according to the Economic Survey 2002-2003, 25 out of 27 public sector banks had CAR above the prescribed minimum level of 9 percent. Of these, as many as 23 banks had CRAR exceeding 10 percent. The two banks which failed to fulfill the minimum capital adequacy norms were Indian Bank and Dena Bank. Of the 30 private sector banks, Centurian Bank and Nedungadi Bank could not attain the minimum CRAR level. Out of the 40 foreign banks operating in the country, only Siam Commercial Bank had a negative CRAR of 13.3 percent. The CRAR of the commercial banks as a whole increased from 11.2 percent at the end of March, 2001 to 11.8 percent at the end of March, 2002.

NPA Recovery

The future of the Indian banking rests on the ability of the bankers to recover its money, especially from those who are wilful defaulters. This will ease pressure on interest rates and genuine borrowers would find it easier to obtain funds from banking channels at competitive rates. In a bid to help the banks and also financial institutions to recover funds, the government enacted the Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The Act allowed creditors to take possession of secured assets; take over the management of secured assets; and to appoint a person to manage them, in case of the failure of the borrower to discharge the liabilities in the stipulated time.

Though the borrower have been allowed to appeal with the Debts Recovery Tribunals, they can do so only after depositing 75 percent of the amount claimed by the secured creditor. Borrowers aggrieved by the order to of the Debts Recovery Tribunal have been permitted to appeal to an Appellate Authority within 30 days from the date of receipt of the order of the tribunal.

The Act, which has become operational, is currently being scrutinised by the Supreme Court. The industry feels that many of the provisions are draconian and the whole act needs to be redrafted. The bankers, on the other hand, are opposed to redrafting of the Act but agreeable to certain procedural changes. The apex court, however, will take a view after listening to the arguments of both sides. Hopefully, the problem would be resolved amicably for the benefit of the both - banks as well as industry - paving the way for easy availability of cheaper credit.

* Mr. Chander Shekhar is Chief of Bureau, Financial Express.
Courtesy : Yojana