MANAGEMENT OF NON-PERFORMING ASSETS

DEFINITION OF NPAS A NPA is a loan or an advance where; Interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan, The account remains “out of order” in respect of an overdraft/ cash credit The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted The installment or interest remains overdue for two crop seasons in case of short duration crops and for one crop season in case of long duration crops

CATEGORIES OF NPA Substandard Assets – Which has remained NPA for a period less than or equal to 12 months. Doubtful Assets – Which has remained in the sub-standard category for a period of 12 months Loss Assets – where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly.

PROVISIONING NORMS Standard Assets – general provision of a minimum of 0.25% Substandard Assets – 10% on total outstanding balance, 10 % on unsecured exposures identified as sub-standard & 100% for unsecured “doubtful” assets. Doubtful Assets – 100% to the extent advance not covered by realizable value of security. In case of secured portion, provision may be made in the range of 20% to 100% depending on the period of asset remaining sub-standard Loss Assets – 100% of the outstanding

FACTORS CONTRIBUTING TO NPAS Poor Credit discipline Inadequate Credit & Risk Management Diversion of funds by promoters Funding of non-viable projects In the early 1990s PSBs started suffering from acute capital inadequacy and lower/ negative profitability. The parameters set for their functioning did not project the paramount need for these corporate goals. The banks had little freedom to price products, cater products to chosen segments or invest funds in their best interest

FACTORS CONTRIBUTING TO NPAS Since 1970s, the SCBs functioned as units cut off from international banking and unable to participate in the structural transformations and new types of lending products. Audit and control functions were not independent and thus unable to correct the effect of serious flaws in policies and directions Banks were not sufficiently developed in terms of skills and expertise to regulate the humongous growth in credit and manage the diverse risks that emerged in the process

FACTORS CONTRIBUTING TO NPAS Inadequate mechanism to gather and disseminate credit information amongst commercial banks Effective recovery from defaulting and overdue borrowers was hampered on account of sizeable overhang component arising from infirmities in the existing process of debt recovery, inadequate legal provisions on foreclosure and bankruptcy and difficulties in the execution of court decrees.

IMPACT OF NPAS ON OPERATIONS Drain on Profitability Impact on capital adequacy Adverse effect on credit growth as the banker’s prime focus becomes zero percent risk and as a result turn lukewarm to fresh credit. Excessive focus on Credit Risk Management High cost of funds due to NPAs

CURRENT STATUS OF NPAS All SCB’s average Net NPA Ratio for 2005-06 is 1.22 (As per RBI’s Statistics) The banks have been able to report lower NPA percentage mostly by providing against or writing off NPAs. The provision to certain extent was facilitated by higher profits on account of treasury management The better Net NPA ratio was also facilitated by higher credit off take resulting in larger asset portfolio/ book size.

NPA MANAGEMENT – PREVENTIVE MEASURES Formation of the Credit Information Bureau (India) Limited (CIBIL) Release of Wilful Defaulter’s List. RBI also releases a list of borrowers with aggregate outstanding of Rs.1 crore and above against whom banks have filed suits for recovery of their funds Reporting of Frauds to RBI Norms of Lender’s Liability – framing of Fair Practices Code with regard to lender’s liability to be followed by banks, which indirectly prevents accounts turning into NPAs on account of bank’s own failure

NPA MANAGEMENT – PREVENTIVE MEASURES Risk assessment and Risk management RBI has advised banks to examine all cases of wilful default of Rs.1 crore and above and file suits in such cases. Board of Directors are required to review NPA accounts of Rs.1 crore and above with special reference to fixing of staff accountability. Reporting quick mortality cases Special mention accounts for early identification of bad debts. Loans and advances overdue for less than one and two quarters would come under this category. However, these accounts do not need provisioning

NPA MANAGEMENT - RESOLUTION Compromise Settlement Schemes Restructuring / Reschedulement Lok Adalat Corporate Debt Restructuring Cell Debt Recovery Tribunal (DRT) Proceedings under the Code of Civil Procedure Board for Industrial & Financial Reconstruction (BIFR)/ AAIFR National Company Law Tribunal (NCLT) Sale of NPA to other banks Sale of NPA to ARC/ SC under Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002 (SRFAESI) Liquidation

Compromise Settlement Schemes Banks are free to design and implement their own policies for recovery and write off incorporation compromise and negotiated settlements with board approval Specific guidelines were issued in May 1999 for one time settlement of small enterprise sector. Guidelines were modified in July 2000 for recovery of NPAs of Rs.5 crore and less as on 31st March 2007.

Restructuring and Rehabilitation Banks are free to design and implement their own policies for restructuring/ rehabilitation of the NPA accounts Reschedulement of payment of interest and principal after considering the Debt service coverage ratio, contribution of the promoter and availability of security

Lok Adalats Small NPAs up to Rs.20 Lacs Speedy Recovery Veil of Authority Soft Defaulters Less expensive Easier way to resolve

Corporate Debt Restructuring The objective of CDR is to ensure a timely and transparent mechanism for restructuring of the debts of viable corporate entities affected by internal and external factors, outside the purview of BIFR, DRT or other legal proceedings The legal basis for the mechanism is provided by the Inter-Creditor Agreement (ICA). All participants in the CDR mechanism must enter the ICA with necessary enforcement and penal clauses. The scheme applies to accounts having multiple banking/ syndication/ consortium accounts with outstanding exposure of Rs.10 crores and above. The CDR system is applicable to standard and sub-standard accounts with potential cases of NPAs getting a priority. Packages given to borrowers are modified time & again Drawback of CDR – Reaching of consensus amongst the creditors delays the process

DRT Act The banks and FIs can enforce their securities by initiating recovery proceeding under the Recovery if Debts due to Banks and FI act, 1993 (DRT Act) by filing an application for recovery of dues before the Debt Recovery Tribunal constituted under the Act. On adjudication, a recovery certificate is issued and the sale is carried out by an auctioneer or a receiver. DRT has powers to grant injunctions against the disposal, transfer or creation of third party interest by debtors in the properties charged to creditor and to pass attachment orders in respect of charged properties In case of non-realization of the decreed amount by way of sale of the charged properties, the personal properties if the guarantors can also be attached and sold. However, realization is usually time-consuming Steps have been taken to create additional benches

Proceeding under Code of Civil Procedure For claims below Rs.10 lacs, the banks and FIs can initiate proceedings under the Code of Civil Procedure of 1908, as amended, in a Civil court. The courts are empowered to pass injunction orders restraining the debtor through itself or through its directors, representatives, etc from disposing of, parting with or dealing in any manner with the subject property. Courts are also empowered to pass attachment and sales orders for subject property before judgment, in case necessary. The sale of subject property is normally carried out by way of open public auction subject to confirmation of the court. The foreclosure proceedings, where the DRT Act is not applicable, can be initiated under the Transfer of Property Act of 1882 by filing a mortgage suit where the procedure is same as laid down under the CPC.

BIFR AND AAIFR BIFR has been given the power to consider revival and rehabilitation of companies under the Sick Industrial Companies (Special Provisions) Act of 1985 (SICA), which has been repealed by passing of the Sick Industrial Companies (Special Provisions) Repeal Bill of 2001. The board of Directors shall make a reference to BIFR within sixty days from the date of finalization of the duly audited accounts for the financial year at the end of which the company becomes sick The company making reference to BIFR to prepare a scheme for its revival and rehabilitation and submit the same to BIFR the procedure is same as laid down under the CPC. The shelter of BIFR misused by defaulting and dishonest borrowers It is a time consuming process

NATIONAL COMPANY LAW TRIBUNAL In December 2002, the Indian Parliament passed the Companies Act of 2002 (Second Amendment) to restructure the Companies Act, 1956 leading to a new regime of tackling corporate rescue and insolvency and setting up of NCLT. NCLT will abolish SICA, have the jurisdiction and power relating to winding up of companies presently vested in the High Court and jurisdiction and power exercised by Company Law Board The second amendments seeks to improve upon the standards to be adopted to measure the competence, performance and services of a bankruptcy court by providing specialized qualification for the appointment of members to the NCLT. However, the quality and skills of judges, newly appointed or existing, will need to be reinforced and no provision has been made for appropriate procedures to evaluate the performance of judges based on the standards

SALE OF NPA TO OTHER BANKS A NPA is eligible for sale to other banks only if it has remained a NPA for at least two years in the books of the selling bank The NPA must be held by the purchasing bank at least for a period of 15 months before it is sold to other banks but not to bank, which originally sold the NPA. The NPA may be classified as standard in the books of the purchasing bank for a period of 90 days from date of purchase and thereafter it would depend on the record of recovery with reference to cash flows estimated while purchasing The bank may purchase/ sell NPA only on without recourse basis If the sale is conducted below the net book value, the short fall should be debited to P&L account and if it is higher, the excess provision will be utilized to meet the loss on account of sale of other NPA.

SARFESI Act 2002 SARFESI provides for enforcement of security interests in movable (tangible or intangible assets including accounts receivable) and immovable property without the intervention of the court The bank and FI may call upon the borrower by way of a written legal notice to discharge in full his liabilities within 60 days from the date of notice, failing which the bank would be entitled to exercise all or any of the rights set out under the Act. Another option available under the Act is to takeover the management of the secured assets Any person aggrieved by the measures taken by the bank can proffer an appeal to DRT within 45 days after depositing 75% of the amount claimed in the notice.

SARFESI Act 2002 Chapter II of SARFESI provides for setting up of reconstruction and securitization companies for acquisition of financial assets from its owner, whether by raising funds by such company from qualified institutional buyers by issue of security receipts representing undivided interest in such assets or otherwise. The ARC can takeover the management of the business of the borrower, sale or lease of a part or whole of the business of the borrower and rescheduling of payments, enforcement of security interest, settlement of dues payable by the borrower or take possession of secured assets Additionally, ARCs can act as agents for recovering dues, as manager and receiver. Drawback – differentiation between first charge holders and the second charge holders

Whether Second Amendment to Companies Act and SARFESI Provide effective and compatible enforcement

Second Amendment & SARFESI The second amendment and SARFESI are a leap forward but requirement exists to make the laws predictable, transparent and affordable enforcement by efficient mechanisms outside of insolvency No definite time frame has been provided for various stages during the liquidation proceedings Need is felt for more creative and commercial approach to corporate entities in financial distress and attempts to revive rather than applying conservative approach of liquidation

Second Amendment & SARFESI Tribunals have largely failed to serve the purpose for which they were set up. NCLT would be over-burdened with workload. Change in eligibility criteria for making a reference would itself generate a greater workload. The second amendment stops short of providing a comprehensive bankruptcy code to deal with corporate bankruptcy.

Second Amendment & SARFESI Does not introduce the required roadmap of the bankruptcy proceeding viz: Application for initiating Appointments & empowerment of trustee Operational and functional independence Accountability to court Monitoring and time bound restructuring Mechanism to sell off Number of time bound attempts for restructuring Decision to pursue insolvency and winding up Strategies for realization and distribution Need for new laws & procedures to handle bankruptcy proceedings in consultation with RBI

NEGOTIATION PROCESS FOR SETTLEMENT OF NON PERFORMING ASSETS

Factors Affecting the Acceptance of Proposal by Bank Bank’s Documentation. Security value. Realizable sale value. Bank’s ability to sell. Ability & Source of the borrower. Ability & Source of the guarantor. Vulnerability of the borrower/guarantor. Time frame. Strength and Zeal of bank's field staff. What message is bank sending out (No in a fraud case.) Banks Policy. Success rate.

Preparation Stage Thorough study of the case Find out our strengths and weaknesses in the case. Find out the vulnerable point/weaknesses of the borrower. Follow-up with the Borrower and Guarantors. Visit factory/Collaterals/residence. Find out properties not charged to the bank. Indicate that Bank is willing to compromise.

ROLE OF CHARTERED ACCOUNTANTS Assist and Prepare Viability study Conduct Business, Assets & Share Valuation Carry out Due Diligence Study for Business Restructuring Verification and Vetting of Documents Preparation of Scheme of Arrangement Consultancy on Taxation aspects Monitoring of Accounts Credit Audit of borrowers Stock Audits

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