The Reserve Bank of India, in its recent Financial Stability Report, has identified deterioration of asset quality as the highest risk facing banks. The RBI has also highlighted the fact that the year-on-year growth of NPAs (non-performing assets), at 30.5 per cent, was higher than the credit growth at 19.2 per cent.
Personal guarantee
While considering loans on the security of personal guarantees, or on the security of properties belonging to the guarantors, it is prudent to ensure that the person offering the personal guarantee/property is a close relative of the borrower.
If the guarantee/property of a third party not in any way connected with the borrower is to be accepted, it is necessary to inquire why he/she is offering the guarantee/security. Often, the security is offered by third parties for a consideration, and when the guarantee is invoked or the property brought to sale, invariably, there is litigation.
There are innumerable cases in which such third parties plead that while signing the guarantee agreements, they were made to believe that they were signing as mere witnesses or that the property was obtained from them by fraudulent means.
They often go to the extent of pleading that the bank was acting in collusion with the borrower. The onus will be on the banker to prove otherwise. Because of the prolonged litigation, it becomes practically impossible to enforce the guarantee/security.
Mortgaging properties
Banks often advance loans on the strength of personal guarantees without insisting on the mortgaging of properties in the name of either the borrower or the guarantors. This is generally done taking into account the reputation of the borrowers/guarantors.
In the case of corporate advances, banks obtain the personal guarantees of directors of the company without insisting on the mortgage of properties in their names. In such cases, banks compile the statement of assets and liabilities of the borrowers and guarantors.
Often, the description of properties of the borrower/guarantor is sketchy without any details. In such cases, it is almost impossible to attach the properties in case there is a need to initiate recovery proceedings.
It is, therefore, necessary to obtain full details of the property, such as survey number, location, extent, and so on, while compiling such statements. It often happens that the properties have already been disposed of by the time the banks initiate steps for attachment. It is, therefore, worth considering whether a ‘negative lien' letter undertaking not to dispose of the properties during the currency of the advance can be taken.
Education loans
Another major threat looming before the banks is the large number of educational loans which are likely to become NPAs in the near future. In fact, the trend has already been set in many banks.
Most of the educational loans, especially in the below Rs 4 lakh category, are now turning into NPAs. The sanction of such loans in large numbers started sometime during 2003-04.
Since no repayment is envisaged during the tenure of the course and for one year thereafter, such accounts were running as performing assets till now. Now, the repayment obligations have started and if there is a default, the accounts turn into NPAs.
There are practically no norms for granting such loans except that the student should have secured admission to a recognised course in a recognised institution.
Reasons for default
The reasons for default in these accounts are broadly as follows:
Many students just about manage to pass the exams and are unable to secure gainful employment and repay the loans.
Even brilliant students who gain employment do not inform the banks about their employment and do not repay these loans. Tracing these borrowers becomes a Herculean task and even the parents do not cooperate with the bankers in recovery.
In a few cases , students secure admission in private colleges who collect a portion of the amount without receipt for which bank loan is not available. Students borrow from outsiders for meeting these expenses. These outsiders are not as considerate as banks and repayments to them are taken care of first, leaving bankers in the lurch.
While there can be no two opinions about the spirit behind the instructions — that no one should be deprived of higher education because of financial constraints — such students also should be made to realise what banks are giving loans from public funds and not grants from the Government.
The Government must permit certain safeguards to ensure that some moral obligation is cast on the borrower to repay the loans without in anyway diluting the spirit of the directives.
Banks should be permitted to obtain the personal guarantees of at least the parents so that they will be able to persuade the student to repay the loan.
In addition, some sort of group guarantee can be thought of. A group of three students who are friends can be made to guarantee each other's loan so that each one will ensure that all members of the group repay the loan.
Another safeguard that can be thought of is to instruct the educational institutions to incorporate the fact of the students having taken loans as well as the name of the bank and the branch in the degree certificates/mark-sheets.
It should be made mandatory on the part of employers to deduct the monthly instalments from the salaries of such students and remit them to the bank. This may require some enabling legislation. Legal luminaries may examine this. The Government should also implement stringent punitive measures against institutions collecting money unauthorisedly.
(The author is a retired banker. The views are personal.)