Combatting The Npa Bogey

Worries over private banks non-performing assets could be exaggerated.

The Money Manager tries to analyse why.

Nostradamus is famous as the man who saw the future. Bankers are not quite so fortunate. They have to rely on calculations and assumptions to make their predictions. And the probability of some, if not all, predictions coming true is nowhere close to 100 per cent.

And if they are to be believed, the recent debate over private banks non-performing assets (NPAs) crossing Rs 100 crore, which to a large extent are a fallout of the projections not coming true, does not spell doomsday about the state of the banking system in India. The reality is far different, says P V Mayya, chairman of ICICI Bank, considered by many as the fastest growing bank in India, because of the rapid growth in its deposits and advances.

 

NPAs are currently considered a four-letter word because of the banking scandals of the early nineties that prompted the Reserve Bank of India (RBI) to introduce new provisioning norms for classifying bank assets.

The new provisioning standards, which conform to international norms, stipulate that banks have to classify loans over Rs 25,000 into four categories: standard, sub-standard, doubtful and loss assets.

Accounting norms for banks have also been strengthened. From fiscal 1995, banks have had to classify assets as non-performing if they do not receive interest on them for two quarters, against three quarters till fiscal 1994. Once an asset gets degenerated in either a doubtful or a loss asset, it has to be provided for in the balance sheet.

Explains Solomon Raj, managing director of the Hinduja-owned IndusInd Bank, When a bank classifies some of its assets as NPAs, it does not de-facto imply that these assets are loss assets. In fact, most of the NPAs existing on the balance sheets are substandard assets, which are usually held against some sort of securities. Incidentally, NPAs of IndusInd Bank, totalling to about Rupees 37 crores, are entirelly substandard NPAs, and not doubtful or loss assets.

For banks, the challenge lies in identifying NPAs early. IndusInd, for example, has a standard appraisal format, which includes a detailed inspection once a quarter. The lending limits are also reviewed every year.

Banks could still end up with NPAs despite all this. But, says Solomon Raj, even a loss asset can have some salvage value. But the chances of an NPA belonging to any other category, especially a substandard asset, becoming good are very high, given the right kind of inputs at the right time.

Mayya says, For this reason, many banks continue to extend lines of credit to these companies and give them another chance. This is very important since, barring promoters intention to defraud banks, most factors are not in the managements control.

Mayya refers to such economic changes as falling tariff barriers that have made foreign goods cheaper and easily available and led to reduced margins for most of the companies. Also, he adds, a general economic slowdown has reduced corporate returns. All such factors have affected the debt servicing capacity of most of the companies, albeit temporarily.

So, he says, it is all the more necessary for banks to help these companies tide over the temporary financial crunch. Without this most such companies, which still have tremendous potential, would have to close. This I feel is more harmful, both to the bank and the economy.

In essence, then, NPAs are part and parcel of an active banking system. Even balance sheets of banks abroad show 2 to 3 per cent NPAs despite the fact that they either write off the previous years NPAs or get a court settlement immediately.

And as Mayya points out, The performance of any project cannot be accurately determined in advance. At most what we have are some kind of projections based on some sound assumptions about the future.

In any case, the risks associated with a project degenerating into an NPA are built into the interest rate structure.

Today, after roughly five years of operation, most private banks NPAs account for less than 5 per cent of their asset base. Private banks business have also grown rapidly, and so have their NPAs, which according to RBI sources have crossed Rs. 100 crores.

Some analysts say NPAs have been mounting because of private banks aggressive marketing. Paresh Sukthankar, head, credit & market risk, HDFC Bank, disagrees. The contention of a segment of the industry, that the new private sector banks have gone overboard in their bid to attract clients of the public sector banks, and in the process got a few NPAs in their hands, is not really true. Why would any bank be interested in taking over the marginal or the under performing assets of the public sector banks? he reasons.

He points to HDFC Banks corporate policy, which permits extending services only to the large manufacturing houses and not to NBFCs, marginal players and trading companies.

Sukthankar adds that aggressiveness does not mean giving more money or limits to clients. It is, in fact, defined in terms of improved and quicker service, adding value to their transactions, faster turnaround and the like, he says.

Ashish Sen, managing director, Centurion Bank, one of the very few private banks to have no NPAs on its balance sheet, agrees. Competition merely for visibility does not pay. The temptation to show more clients and get more media attention can prove disastrous for the banks balance sheets if due caution and financial judgment is not exercised, he says.

Sen attributes Centurions zero NPA status to the banks focus on qualitative instead of quantitative growth. We have been very careful in lending, in choosing our customers and gathering information about them at regular intervals, he says. And Centurian bank, like all banks, has sufficient internal safeguards in the form of the prudential norms, which restrict the exposure of the bank to any group.

But with the growing volume of transactions, will it still be feasible for the banks to monitor all its clients so closely? Yes, says IndusInds Solomon Raj. His bank relies on external consultants to gather information on the clients and monitor them. But what is really required is good and healthy information network between various banks and availability of sufficient market information about companies, he says.

This information is required to get the total liabilities of a company or its promoters from the entire system, which is very essential to form a comprehensive picture. As long as consortium financing was compulsory, this information was easily available, but now we require credit report agencies, on the lines of Dun & Bradstreet, to collect all this information and also the information from the markets, says Raj.

Sukthankar concurs and says, the current level of transparency between banks is very cursory and general. Detailed information is either not available with the banks and the rating agencies, or they do not want to part with it for fear of loosing the customer. This area requires lot of improvement.

Sen believes that no company suddenly comes into cash flow crises. The signals are visible far in advance to the discerning banker, he says, and adds, we insist on cash budgeting, which assists us in forecasting the problems our customers will face in meeting their commitments. Apart from this, we have a process of continuous monitoring and detailed cash flow analysis.

Another major problem, feels Mayya, exists on the loan recovery front. Serious recovery efforts on the part of the government are required. The judicial system is so lengthy, unreliable and obsolete that if at all possible, it can takes ages to recover the sum that is rightfully yours. The Debt Recovery Tribunals set up about five years back have hardly done anythig worthwhile, primarily because of the infrastructure and legal hurdles.

The allegation of widespread window dressing of the balance sheets by the private sector banks to hide their NPAs, for example by extending short term ad-hoc loans to these corporates, which are routed back to the banks as interest payments, is also not very rampant. Any kind of advances given by the bankers are only to bring the asset back, and always within the regulatory provisions, says Sukthankar.

All in all, however, the management of the most private banks are confident of controlling their NPAs to within the 5 per cent limits specified for public sector banks, in the Tarapore committee report on capital account convertibility.

On the other hand, many bankers feel that it will be difficult for public sector banks to achieve this target primarily because of political intervention and loan melas which have saddled these banks with a huge amount of under performing assets. Private bank officials are not soothsayers, but they reckon that their professional management should help keep the NPA bogey away.