NPA, a multi-headed monster

Non-performing asset (NPA) is a multi-headed monster having multiple implications on the performance of banks. An immediate offshoot of rising NPAs is the higher provision required. Once an account is classified as NPA it goes through several phrases requiring progressively higher provisions.

A sub-standard Asset requires a provision of 15 per cent on secured portion and 25 per cent on the unsecured exposure. After 12 months as Sub-Standard Asset, it gets classified as Doubtful Asset 1(DA1) and requires a provision of 25 per cent on secured portion and 100 per cent on the unsecured portion.

Once the account crosses one year as DA1, it becomes Doubtful Asset 2 (DA2-1to 3 years) and requires a provision of 40 per cent on the Secured portion and 100 per cent on the unsecured portion.

Once it crosses three years, it becomes Doubtful Asset3 (DA3) and requires 100 per cent provision irrespective of the availability of security. Unsecured loans such as clean loans, educational loans attract 100 per cent provision even at DA1 stage.

Accounts classified as fraud need not go through all these stages and will require 100 per cent provision as soon as it is classified as NPA. Such provisions have to be made out of the profits of the year thus, eroding the bottom line.

The remedy lies in an effective recovery mechanism and the tightening of sanction and appraisal procedures for which I propose to make some suggestions in addition to the ones I had made in my previous articles.

The prevention and recovery of NPAs also require some banker friendly initiatives by the Government and its agencies.

The judiciary also has a role in the mitigation of banks' hardships by having stringent standards for granting a Stay against the recovery measures initiated by the bank and rejecting frivolous objections raised by the borrowers in the initial stage itself.

A large chunk of NPAs comes from Government-sponsored schemes which are target-oriented and require to be granted without any detailed appraisal and without looking into the viability of the project.

The applications are sponsored by Government agencies like the District Industries Centre or other agencies created for specific schemes. In the case of loans secured by mortgage of immovable properties, the security is created by way of equitable mortgage that is, simple deposit of deposit of title deeds.

This does not require registration and the mortgage charge is transferred under Sec 58(f) of the Transfer of Property Act. Since this is not registered, it does not find a place in the Encumbrance certificates.

There have been several cases where the borrowers have sold the property or mortgaged it to a second lender pleading that the original title deeds have been lost. Even though such a sale/second mortgage a sale is not legally valid, banks have to go through the cumbersome procedure of impleading the buyer of the property in the recovery suit for proving its case.

Some States have introduced a system of registering the memorandum of title deeds. (A simple letter signed by the mortgagor confirming that he had deposited the original title deeds with the Bank with the intention of creating a mortgage).

This attracts Stamp Duty and encounters a lot of resistance from the borrower. Further, many banks have lost substantial amounts because of unscrupulous borrowers resorting to multiple borrowing from different banks on the same immovable property. To overcome these problems, a Central Registry has been established by an amendment to the SARFAESI ACT.

All charges (other than pledge) created on properties and assets of borrowers favouring banks and other notified financial institutions shall be registered with a Central Registrar appointed by the Government. This has come into effect from April 1 last year.

While this is a welcome step, which will largely prevent fraudulent transactions of the above nature, the sheer volume of such mortgage transactions makes maintenance of such records a daunting task. Further the task will be complete and effective only when all existing mortgages are recorded in the Central Registry.

At present, there is no provision for this in the Act. The Union Government should take immediate steps to constitute the National Company Law Tribunal and the appellate Tribunal for speedy resolution of the cases involving sick industrial units to avoid delays arising out of referring such cases to BIFR.

Often, banks in their anxiety to prevent slippage resort to restructuring of accounts without looking into the long term viability of the project. This is only a postponement of the inevitable, and such accounts more often than not turn into NPAs at a later date as has happened in the case of accounts restructured during 2008-09.

Finally, as has been pointed out in the Financial Stability Report of RBI, while Indian banks will migrate to Basle III from a position of strength, the new standards may require adjustments in lending behaviour.

As the Deputy Managing Director of SBI has pointed out recently, more rigorous standards of appraisal have to be applied while considering fresh exposures and the vulnerable sectors like power, aviation, textiles and real estate have to be assessed taking into account the competition and rising costs involved.

(The author is a retired banker. The views are personal.)