Non-Performing Assets (NPA) - Meaning

Non-Performing Assets are popularly known as NPA. Commercial Banksassets are of various types.
All those assets which generate periodical income are called as Performing Assets (PA).
While all those assets which do not generate periodical income are called asNon-Performing Assets (NPA).
If the customers do not repay principal amount and interest for a certain period of time then such loans become non-performing assets (NPA). Thus non-performing assets are basically non-performing loans.
In India, the time frame given for classifying the asset as NPA is 180 days as compared to 45 days to 90 days of international norms
India and Non-Performing Assets
In India, NPA were very high in the beginning of 90's. Over a period of time there is considerable decline in the NPA's of all banks. In the case of public sector banks, gross non-performing assets were 9.4% in 2002-03 and it declined to 7.8% in 2003-04. The net NPA during the same period declined from 4.5% to 3%.

Types of NPA
NPA have been divided or classified into following four types:- 1. Standard Assets : A standard asset is a performing asset. Standard assets generate continuous income and repayments as and when they fall due. Such assets carry a normal risk and are not NPA in the real sense. So, no special provisions are required for Standard Assets. 2. Sub-Standard Assets : All those assets (loans and advances) which are considered as non-performing for a period of 12 months are called as Sub-Standard assets. 3. Doubtful Assets : All those assets which are considered as non-performing for period of more than 12 months are called as Doubtful Assets. 4. Loss Assets : All those assets which cannot be recovered are called as Loss Assets.
These assets can be identified by the Central Bank or by the Auditors.

Provision on types of assets Provision is allocating money every year to meet possible future loss.

Causes of NPA NPA arises due to a number of factors or causes like:- 1. Speculation : Investing in high risk assets to earn high income. 2. Default : Willful default by the borrowers. 3. Fraudulent practices : Fraudulent Practices like advancing loans to ineligible persons, advances without security or references, etc. 4. Diversion of funds : Most of the funds are diverted for unnecessary expansion and diversion of business. 5. Internal reasons : Many internal reasons like inefficient management, inappropriate technology, labour problems, marketing failure, etc. resulting in poor performance of the companies. 6. External reasons : External reasons like a recession in the economy, infrastructural problems, price rise, delay in release of sanctioned limits by banks, delays in settlements of payments by government, natural calamities, etc.

Changing Role of Banks in India

The role of banks in India has changed a lot since economic reforms of 1991. These changes came due to LPG, i.e. liberalization, privatization and globalization policy being followed by GOI. Since then most traditional and outdated concepts, practices, procedures and methods of banking have changed significantly. Today, banks in India have become more customer-focused and service-oriented than they were before 1991. They now also give a lot of importance to their rural customers. They are even willing ready to help them and serve regularly the banking needs of country-side India.
The following points briefly highlight the changing role of banks in India.

1. Better Customer Service
Before 1991, the overall service of banks in India was very poor. There were very long queues (lines) to receive payment for cheques and to depositmoney. In those days, some bank staffs were very rude to their customers. However, all this changed remarkably after Indian economic reforms of 1991.
Banks in India have now become very customer and service focus. Their service has become quick, efficient and customer-friendly. This positive change is mostly due to rising competition from new private banks and initiation of Ombudsman Scheme by RBI.

2. Mobile Banking
Under mobile banking service, customers can easily carry out major banking transactions by simply using their cell phones or mobiles.
Here, first a customer needs to activate this service by contacting his bank. Generally, bank officer asks the customer to fill a simple form to register (authorize) his mobile number. After registration, this service is activated, and the customer is provided with a username and password. Using secret credentials and registered phone, customer can now comfortably and securely, find his bank balance, transfer money from his account to another, ask for a cheque book, stop payment of a cheque, etc. Today, almost all banks in India provide a mobile-banking service.

3. Bank on Wheels
The 'Bank on Wheels' scheme was introduced in the North-East Region of India. Under this scheme, banking services are made accessible to people staying in the far-flung (remote) areas of India. This scheme is a generous attempt to serve banking needs of rural India.

4. Portfolio Management
In portfolio management, banks do all the investments work of their clients.
Banks invest their clients' money in shares, debentures, fixed deposits, etc. They first enter a contract with their clients and charge them a fee for this service. Then they have the full power to invest or disinvest their clients' money. However, they have to give safety and profit to their clients.

5. Issue of Electro-Magnetic Cards
Banks in India have already started issuing Electro-Magnetic Cards to their customers. These cards help to carry out cash-less transactions, make an online purchase, avail ATM facility, book a railway ticket, etc.
Banks issue many types of electro-magnetic cards, which are as follows: 1. Credit cards help customers to spend money (loaned up to a certain limit as previously settled by the bank) which they don't have in hand. They get a monthly statement of their purchases and withdrawals. Along with the transacted amount, this statement also includes the interest and service fee. The entire amount (as reflected in the statement of credit card) must be paid back to the bank either fully or in installments, but before due date. 2. Debit cards help customers to spend that money which they have saved (credited) in their individual bank accounts. They need not carry cash but instead can use a debit card to make a purchase (for shopping) and/or withdraw money (get cash) from an ATM. No interest is charged on the usage of debit cards. 3. Charge cards are used to spend money up to a certain limit for a month. At the end of the month, customer gets a statement. If he has a sufficient balance, then he only had to pay a small fee. However, if he doesn't have a necessary balance, he is given a grace period (which is generally of 25 to 50 days) to repay the money. 4. Smart cards are currently being used as an alternative to avail public transport services. In India, this covers Railways, State Transport and City (Local) Buses. Smart card has an integrated circuit (IC) embedded in its plastic body. It is made as per norms specified by ISO. 5. Kisan credit cards are used for the benefit of the rural population of India. The Indian farmers (kisans) can use this card to buy agricultural inputs and goods for self-consumption. These cards are issued by both Commercial and Co-operative banks.

6. Universal Banking
In India, the concept of universal banking has gained recognition after year 2000. The customers can get all banking and non-banking services under one roof. Universal bank is like a super store. It offers a wide range of services, including banking and other financial services like insurance,merchant banking, etc.

7. Automated Teller Machine (ATM)
There are many advantages of ATM. As a result, many banks have opened up ATM centres to offer convenience to their customers. Now banks are operating ATM centres not only in their branches but also at public places like airports, railway stations, hotels, etc. Some banks have joined together and agreed upon to set up common ATM centres all over India.

8. Internet Banking
Internet banking is also called as an E-banking or net banking. Here, the customer can do banking transactions through the medium of the internet or world wide web (WWW). The customer need not visit the bank's branch. Through this facility, the customer can easily inquiry about bank balance, transfer funds, request for a cheque book, etc. Most large banks offer this service to their tech-savvy customers.

9. Encouragement to Bank Amalgamation
Failure of banks is well-protected with the facility of amalgamation. So depositors need not worry about their deposits. When weaker banks are absorbed by stronger banks, it is called amalgamation of banks.

10. Encouragement to Personal Loans
Today, the purchasing power of Indian consumers has increased dramatically because banks give them easy personal loans. Generally, interest charged by the banks on such loans is very high. Interest is calculated on reducing balance. Large banks offer loans up to a huge amount like one crore. Some banks even organise Loan Mela (Fair) where a loan is sanctioned on the spot to deserving candidates after they submit proper documents.

11. Marketing of Mutual Funds
A mutual fund collects money from many investors and invests the money in shares, bonds, short-term money market instruments, gold assets; etc. Mutual funds earn income by interest and dividend or both from its investments. It pays a dividend to subscribers. The rate of dividend fluctuates with the income on mutual fund investments. Now banks have started selling these funds in their own names. These funds are not insured like other bank deposits. There are different types of funds such as open-ended funds, closed-ended funds, growth funds, balanced funds, income funds, etc.

12. Social Banking
The government uses the banking system to alleviate poverty and unemployment. Many social development programmes are initiated by the banks from time to time. The success of these programmes depends on financial support provided by the banks. Banks supply a lot of finance to farmers, artisans, scheduled castes (SC) and scheduled tribe (ST) families, unemployed youth and people living below the poverty line (BPL).

ROLE OF DEVELOPMENT BANKS IN INDIA 1. Capital Formation: The significance of Development Finance Institutions or DFIs lies in their making available the means to utilize savings generated in the economy, thus helping in capital formation. Capital formation implies the diversion of the productive capacity of the economy to the making of capital goods which increases future productive capacity. The process of Capital Formation involves three distinct but interdependent activities, viz., saving financial intermediation and investment. However, poor country/economy may be, there will be a need for institutions which allow such savings, as are currently forthcoming, to be invested conveniently and safely and which ensure that they are channeled into the most useful purposes. A well-developed financial structure will therefore aid in the collections and disbursements of investible funds and thereby contribute to the capital formation of the economy. Indian capital market although still considered to be underdeveloped has been recording impressive progress during the post-interdependence period. 2. Support to the Capital Market:
The basic purpose of DFIs particularly in the context of a developing economy, is to accelerate the pace of economic development by increasing capital formation, inducing investors and entrepreneurs, sealing the leakages of material and human resources by careful allocation thereof, undertaking development activities, including promotion of industrial units to fill the gaps in the industrial structure and by ensuring that no healthy projects suffer for want of finance and/or technical services. Hence, the DFIs have to perform financial and development functions on finance functions, there is a provision of adequate term finance and in development functions there include providing of foreign currency loans, underwriting of shares and debentures of industrial concerns, direct subscription to equity and preference share capital, guaranteeing of deferred payments, conducting techno-economic surveys, market and investment research and rendering of technical and administrative guidance to the entrepreneurs.

3. Rupee Loans:
Rupee loans constitute more than 90 per cent of the total assistance sanctioned and disbursed. This speaks eloquently on DFI’s obsession with term loans to the neglect of other forms of assistance which are equally important. Term loans unsupplemented by other forms of assistance had naturally put the borrowers, most of whom are small entrepreneurs, on to a heavy burden of debt-servicing. Since term finance is just one of the inputs but not everything for the entrepreneurs, they had to search for other sources and their abortive efforts to secure other forms of assistance led to sickness in industrial units in many cases. 4. Foreign Currency Loans:
Foreign currency loans are meant for setting up of new industrial projects as also for expansion, diversification, modernization or renovation of existing units in cases where a portion of the loan was for financing import of equipment from abroad and/or technical know-how, in special cases. 5. Subscription to Debentures and Guarantees:
Regarding guarantees, it is well-known that when an entrepreneur purchases some machinery or fixed assets or capital goods on credit, the supplier usually asks him to furnish some guarantee to ensure payment of installments by the purchaser at regular intervals. In such a case, DFIs can act as guarantors for prompt of installments to the supplier of such machinery or capital under a scheme called ‘Deferred Payments Guarantee’. 6. Assistance to Backward Areas:
Operations of DFI’s in India have been primarily guided by priorities as spelt out in the Five-Year Plans. This is reflected in the lending portfolio and pattern of financial assistance of development financial institutions under different schemes of financing. Institutional finance to projects in backward areas is extended on concessional terms such as lower interest rate, longer moratorium period, extended repayment schedule and relaxed norms in respect of promoters’ contribution and debt-equity ratio. Such concessions are extended on a graded scale to units in industrially backward districts, classified into the three categories of A, B and c depending upon the degree of their backwardness. Besides, institutions have introduced schemes for extending term loans for project/area-specific infrastructure development. Moreover, in recent years, development banks in India have launched special programmes for intensive development of industrially least developed areas, commonly referred to as the No-industry Districts (NID’s) which do not have any large-scale or medium-scale industrial project. Institutions have initiated industrial potential surveys in these areas. 7. Promotion of New Entrepreneurs:
Development banks in India have also achieved a remarkable success in creating a new class of entrepreneurs and spreading the industrial culture to newer areas and weaker sections of the society. Special capital and seed Capital schemes have been introduced to provide equity type of assistance to new and technically skilled entrepreneurs who lack financial resources of their own even to provide promoter’s contribution in view of long-term benefits to the society from the emergence of a new class of entrepreneurs. Development banks have been actively involved in the entrepreneurship development programmes and in establishing a set of institutions which identify and train potential entrepreneurs. Again, to make available a package of services encompassing preparation of feasibility of reports, project reports, technical and management consultancy etc. at a reasonable cost, institutions have sponsored a chain of 16 Technical Consultancy organizations covering practically the entire country. Promotional and development functions are as important to institutions as the financing role. The promotional activities like carrying out industrial potential surveys, identification of potential entrepreneurs, conducting entrepreneurship development programmes and providing technical consultancy services have contributed in a significant manner to the process of industrialization and effective utilization of industrial finance by industry. IDBI has created a special technical assistance fund to support its various promotional activities. Over the years, the scope of promotional activities has expanded to include programmes for up gradation of skill of State level development banks and other industrial promotion agencies, conducting special studies on important issues concerning industrial development, encouraging voluntary agencies in implementing their programmes for the uplift of rural areas, village an cottage industries, artisans and other weaker sections of the society. 8. Impact on Corporate Culture:
The project appraisal and follow-up of assisted projects by institutions through various instruments, such as project monitoring and report of nominee directors on the Boards of directors of assisted units, have been mutually rewarding. Through monitoring of assisted projects, the institutions have been able to better appreciate the problems faced by industrial units. It also has been possible for the corporate managements to recognize the fact that interests of the assisted units and those of institutions do not conflict but coincide. Over the years, institutions have succeeded in infusing a sense of constructive partnership with the corporate sector. Institutions have been going through a continuous process of learning by doing and are effecting improvements in their systems and procedures on the basis of their cumulative experience.
The promoters of industrial projects now develop ideas into specific projects more carefully and prepare project reports more systematically. Institutions insist on more critical evaluation of technical feasibility demand factors, marketing strategies and project location and on application of modern techniques of discounted cash flow, internal rate of return, economic rate of return etc., in assessing the prospects of a project. This has produced a favorable impact on the process of decision-making in the corporate seeking financial assistance from institutions. In fact, such impact is not continued to projects assisted by them but also spreads over to projects financed by the corporate sector on its own.
The association of institutions in the management of corporate bodies has considerably facilitated the process of progressive professionalism of the corporate management. Institutions have been able to convince the corporate managements to appropriately re-orient their organizational structure, personal policies and planning and control systems. In many cases, institutions have successfully inducted experts on the Boards of assisted companies. As part of their project follow-up work and through their nominee directors, institutions have also been able to bring about progressive adoption of modern management techniques, such as corporate planning and performance budgeting in the assisted units. The progressive professionalism of industrial management in India reflects one of the major qualitative changes brought about by the institutions

Priority Sector Lending Meaning

Priority sector plays an important role in the economic development of the country. Therefore, the Central (Federal) Government of any country gives this sector priority (first preference) in obtaining loans from banks at a low rate of interest. This is known as a ‘Priority Sector Lending’.

Following important points cover the core meaning of priority sector lending: 1. Priority sector lending scheme is a policy of providing a specified portion of bank lending to the important sectors of the economy. 2. It includes agriculture, small-scale industries, cottage sector, tiny sector, export sector, and other small business (service) firms. 3. The Reserve Bank of India (RBI) was first to initiate priority sector lending scheme in India. 4. The main purpose of this scheme was to see that timely and sufficient credits (loans) are given (provided) to the priority sector. 5. Previously, only public sector banks were asked to give loans to this sector. However, now even private and foreign banks have to give loans to this sector.

Areas Under Priority Sector
RBI has divided the priority sector into following ten areas or categories.
The main areas under priority sector lending scheme are as follows: 1. Agriculture sector. 2. Small-scale industrial loans. 3. Small road and water transport operators. 4. Professional and self-employed. 5. Retail trade loan. 6. Educational loan. 7. Housing loan 8. Consumption loan 9. State-sponsored corporations for SC/ST. 10. Other recommended priority sectors.
Now let's discuss individual areas under priority sector lending one by one.

1. Agriculture sector

In India, nearly one-third of its national income come from the agriculture sector. Its economic and social development directly depends on the expansion of the agriculture sector. Therefore, it is treated as primary priority sector lending in India.
Agricultural loans are given to the farmers on their need-based credit.
These loans are classified into following two categories:

1. Direct Agricultural Loans

Under this category, loans are directly given to the farmers in form of tractor loan, dairy loan, crop loan, etc. These loans are given either for a short-term period (which is not more than 12 months) or for a medium and long-term period (which is not more than 36 months). 1. Short-term loans are given to meet agricultural expenses and maintenance of assets such as a tractor, pumping machine, bore well, etc. 2. Medium and long-term loans are given for agricultural activities like land reclamation, farm building, farm mechanization, and so on.
2. Indirect Agricultural Loans

Here, farmers are provided loans at concessional rates of interest. Indirect agricultural loans benefit the farmers in the long run. These loans are given for cattle feed, warehouse, seeds, pesticides, rural electrification, subscription of bonds issued by NABARD, boring equipments, etc.

2. Small-scale industrial loans

Loans given to small-scale and ancillary industries are treated as priority sector lending. These industrial units are those who do manufacturing, processing, and preservation of goods.

In case of these industries, investment made in fixed assets must not exceed the maximum limit notified by the Government of India. Such small-scale and ancillary industries create newer job opportunities in the market.
Small-scale and ancillary industries include tailoring, Xeroxing, typing centers, etc.

3. Small road and water transport operators

This category of borrowers includes owners of taxis, trucks, buses, auto-rickshaws, cars, bullock-carts, camel, etc. Under priority sector lending, small road and transport operators get loans based on the conditions mentioned in the notification issued by the Government of India.
The repayment period of loan is communicated to the borrower at the time of disbursement of loan.

Borrowing is done for the purchase of vehicles and their parts. Bank mainly provides loans for the following purposes: 1. Purchase of vehicles. 2. Purchase of spare parts. 3. Carrying out major repairs. 4. Working capital requirements.

4. Professional and self-employed

Under this category, bank provides loans to professionals like: 1. Doctors, 2. Chartered accountants, 3. Architects, 4. Engineers, 5. Lawyers, etc.

Bank also provided loans to self-employed persons like: 1. Freelance journalists, 2. Owners of health care centers, 3. Beauty parlors, 4. Photographers, 5. Fashion designers, and so on.
The borrowing limit will be an aggregate of fixed capital and working capital requirements of a professional and self-employed person.
Doctors and other self-employed professionals who start practicing in rural or semi-urban areas are also eligible to borrow loans.

5. Retail trade loan

Under priority sector lending, retail trader trading in fertilizers, mineral oil, fair price shops and consumers' co-operative stores get bank loans.
The loaned amount can be used to purchase fixed assets, tools and other equipments needed to carry on trading and its allied activities.

Image credits © Moon Rodriguez.

6. Educational loan

Education loan is given to those students who want to pursue higher education in India or abroad.

Generally, bank provides loans to students on the following conditions: 1. The Government of India set limits on the amount of educational loan taken by students for pursuing studies in Indian and/or abroad. 2. Students may undergo graduation, post graduation (masters) programs, professional programs and other job-oriented diplomas. 3. Rate of interest on educational loan varies in accordance with the latest ‘Finance Bill’ issued by the Government of India.

7. Housing loan

Types of housing loan under priority sector lending are depicted below.

Under housing loan facilities, following types of loans are available for: 1. Construction of a house. 2. Repair (maintenance) and/or renewal of a house. 3. Clearance of slums and rehabilitation of disaster-stricken masses to temporary refuge shelters.

8. Consumption loan

Banks provide the consumption loan to weaker sections of society that include small farmers, landless agricultural workers, rural artisans, barbers, washer men, carpenters, and so on who have no savings in their hands.

People of weaker sections need to borrow money for their immediate requirements like marriage, festivals, illnesses, etc.
Consumption loan is given for such non-productive purposes.
Here, loan limit is prescribed on each family.

9. State-sponsored corporations for SC/ST

Priority sector lending includes loans given to state-sponsored corporations for the promotion of scheduled castes (SC) and scheduled tribes (ST).

Banks are given freedom to decide the amount and also the terms and conditions for these loans.

10. Other recommended priority sectors

Some other recommended priority sectors are depicted below:

These are listed and briefly explained as follows:
1. Software Industry

Here, loans are given to a software industry up to a limit as per the notification issued by the government of India.
Software professionals are given loans under the category of “Loans to professionals and self-employed”.
2. Venture Capital

If the venture capital project is registered with ‘SEBI’ (Securities and Exchange Board of India) then it will be included in the priority sector lending.
It will get a loan under priority sector lending scheme.

http://www.cab.org.in/Lists/Knowledge%20Bank/Attachments/34/INCOME.pdf
SHOT NOTES ON PRUDENTIAL NORMS

A. Capital Adequacy
While banks' income mainly comes out of lending and investment activities, they utilize the funds deposited with them by Customers for these purposes. When their investment or lending decisions go wrong, it result into loss to the bank.
In order that the banks involve their own funds adequately to bear such losses, RBI prescribed capital adequacy norms. Presently, all commercial banks are required to have a minimum capital of 8 per cent to the Risk Weighted Assets of Banks. This ratio is known as CRAR, i.e., Capital to Risk Assets Ratio. This was raised to 9 per cent by 31st March 2000.
'Capital' for the purpose of this norm is divided into two parts, viz., Tier I and Tier II Capital.
(i) Tier I Capital:
It consists of paid-up capital, Banks' Statutory Reserves, Free Reserves (those not earmarked for meeting any specific liability) and capital reserves arising out of sale "proceeds of any assets. It will not include reserves arising out of revaluation of assets. However, accumulated losses, investments in banks' subsidiaries and any intangible assets like Goodwill will be deducted from the above items to arrive at the minimum. Capital adequacy.
(ii) Tier II Capital:
It consists of paid-up value of Perpetual Preference Shares, Revaluation Reserves, paid-up value of unsecured Bonds issued as subordinated debt, General Provisions and Loss Reserves. It should be noted that certain items like Revaluation Reserves, etc., are not taken 100% of their value for this purpose.
Their value is discounted to certain percentage e.g., Revaluation Reserves discounted to the extent of 55 per cent and only the balance sum is included in Tier II Capital. Another condition is that Tier II Capital cannot exceed 50% of Tier I Capital for the purpose of arriving at the prescribed capital adequacy ratio.
Students are reminded that detailed natty gritty and complexities involved in their calculation or understanding of the subject is not discussed here. The basic objective of explaining the various concepts is only to educate the students about their applicability and the meaning and importance of such new concepts in the Indian Banking Scenario.
(iii) Risk Weighted Assets:
The requisite percentage of capital adequacy discussed above should be maintained with reference to various assets of the banks. However, the assets are not taken at their book value. The value of each asset is assigned with the risk factor in percentage terms.
CRAR at 9 per cent on Rs.150 crore is required to be maintained. Hence, in such a situation the bank is expected to have a minimum capital of Rs.13.50 crore which can consist of Tier I and Tier II capital items subject to Tier II value not exceeding that of Tier I value.
Again to illustrate, supposing the total value of items indicated under Tier I heading amounts to Rs. 6.00 crore and that of Tier II amounts to Rs. 8.00 crore, the bank will be failing to maintain the requisite CRAR of Rs.13.50 crore as a maximum of only Rs. 3.00 crore under Tier II (being the maximum at 50 per cent of Tier I capital) will be eligible for computation.
(iv) Subordinated Debt:
These are bonds issued by banks for raising Tier II capital having the following features:
They should be fully paid up instruments
They should be unsecured debt
They should be subordinated to the claims of other creditors (It means that the bond holders' claim for their money will rank last in order of preference as compared to claims of other creditors of banks).
The bonds should not be redeemable at the option of the holders. In other words repayment of the bond value will be decided only by the issuing bank.
B. Income Recognition
Irksome from an asset (like Loans and Advances of Banks) can be taken to Profit and Loss A/c only if the income is actually received. Income should not be booked on accrual basis. In other words, incomes like interest earned but not received will not be allowed to be credited to Profit and Loss Account