Regulations for Non-Performing Assets – How effective is the implementation?

Lending for capital investment, infrastructure projects, and heavy industries contributes to the development of the economy and also provides long-term assured income to banks. Such corporate loans occupy a significant asset portfolio in most large banks. Project feasibility, credit risk, cash flow, balance sheet analysis, industry analysis, promoter interest and stake, creditworthiness etc. are meticulously scrutinized and reported during loan assessment. Depending on the banks’ capital and limits assigned for lending based on different industry norms, approval from the Board is obtained before clearing the loans. The bifurcation of the limit structure could be a combination of fund based (working capital and term loan) and non-fund based documentary credit/ Bank Guarantee as per the applicant’s request or credit assessment. In case the borrower is involved in exports and imports, things such as a foreign currency loan limit and pre-shipment/post shipment credit come into play. Before disbursing the loan, several officers inspect the terms and conditions and record their observations in the credit note sections.

The performance of these loans is closely monitored and in many countries, their Central Banks have formulated norms for classifying non-performing loans (where there is a default in repayment). Sometimes, there may be non-performance contrary to expected norms which could indicate that the borrower is diverting funds to associate businesses; close monitoring is required to prevent such instances. Across the globe, Basel II, Basel III and Basel IV norms are available for measuring credit risk and capital adequacy ratio based on risk weighed assets. Market risks arising in the future – exchange rate risks, industry failure, export/import issues etc. – can also lead to non-performance or repayment default by the corporate borrower.

Most banks use pre-processing or origination software for credit application analysis, credit scoring and credit decisioning in the case of large corporate borrowers; a few still use manual credit monitoring assessment tools. Post approval, limit booking and account opening are done by the lending servicing software. When the software is available at the branches but can be accessed by the bank’s Central Credit Cell, all transactions, be they disbursements or repayments, are viewed and monitored. There are software provisions available for checking non-financial conditions like non-submission of stock statements or non-submission of IT returns periodically during the lending life cycle to assess the health of the account.

Checks and computing software notwithstanding, there is both human intervention and subjectivity in NPA assessment. Banks are reluctant to book a loan as non-performing considering the huge interest amount, which is booked periodically and the associated provisioning which impacts the P&L. There is also a huge reputational impact to the borrower and the company’s business when a loan is termed an NPA. A few of the data provisions in the software need to be modified and some exceptions in the servicing or NPA software overridden manually to classify the loan as performing. To be precise, banks adopt a conservative approach in classifying corporate loans as NPA when compared to small loans. Reducing manual intervention to the extent possible and automating activities through systems and software is definitely required.

Central Banks such as the Reserve Bank of India have requested banks to periodically submit returns for all large borrowers including different parameters like amount sanctioned, amount availed, industry classifications, repayments made etc., to monitor the performance of these accounts remotely. It is possible that some of these data elements are neither captured nor reported accurately resulting in fallacious information being provided to the Reserve Bank. The Reserve Bank on its own conducts periodic inspections and reports the irregularities to banks’ top management. Any delay in conducting the inspection after the account has gone bad, preparing the report after the inspection, review by authorities and final communication for action reaching the top management may cause the account to deteriorate further or require the promoter to make some adjustments in the interim.

Though the NPA guidelines/regulations/policies framed by the Reserve Bank are largely in line with global standards, the measures taken by banks are only partially successful in controlling the mounting NPAs of public sector banks in India. Some banks and borrowers have relationships outside of accepted banking norms and principles, which could prevent NPAs being given the proper treatment. Usually companies’ top managements know key bank officials and government authorities at the highest level, which could work to their advantage. Banks are even able to circumvent the software to dilute the conditions for borrowing.

To conclude, the measures or principles for classifying a loan as a bad asset are not followed as per regulations; human intervention prevents the software from automatically classifying the account. There are also numerous provisions for NPAs which are added or modified every year by the Central Bank of each country and bank officials use this to their advantage, pretending to be unaware of the latest guidelines, deliberately misinterpreting clauses, not responding to communication issued by the Head Office or Central Bank, or not explicitly mentioning the clauses about provisions applicable to different industries, and so on. Though software vendors want to update their NPA software with the new additions, different interpretations of the same guideline by different banks make it difficult to adopt a common approach for building the software. An effective early NPA warning and implementation measures by banks are seldom useful in curbing NPAs

The Central Bank of each country needs to examine the practicality of building software for only NPA management, which can be changed easily and made to work on top of any core banking or lending software for better control and monitoring. Banks can share the data periodically or as desired by their Central Bank online and for the Central Bank to run the data through this NPA software. The Central Bank (and only the Central Bank) can thus approve or reject any exceptions / deviations. It does not augur well to have post facto rules or modifications to existing norms after an incident has occurred. There could be policies framed for centrally controlling the large corporate accounts through a separate institution with an external rolling committee of analysts and consultants (who can be appointed by the RBI involving non-RBI and non-bank officials) who will periodically scrutinize such accounts and provide their recommendations. They can independently monitor and review these accounts whereas accounting, loan booking, interest applications, and loan transactions can continue to remain in the original bank. The names of corporate entities having exposure above a certain threshold amount can be made public (in the banks’ balance sheets or on publicly accessible portals or through reputed credit agencies) making them accountable for repaying their loans. Irrespective of the future changes envisaged by the regulator, there should be stricter policies to control the mounting NPAs in public sector banks in India which could potentially erode a large part of their capital and derail the economy. The Reserve Bank of India cannot silently watch this deterioration and evade responsibility. It should proactively frame guidelines and policies by involving bank leaders, government officials, industry experts etc. and ensure they are implemented.