RBI needs to come out clean on NPAs

If NPAs are not curbed effectively, it will not be long before we in India head the Greek route. The banks should not stop short of opting for strong coercive proceedings under the securitization laws rather than yield to the mirage of CDR

In the west, post-Lehman brothers has brought about new financial jargons like bailout for stressed assets in the USA, here in India they are termed non-performing assets (NPAs). Both simply stand for bad or irrecoverable loans/debts by whatever name they are called.

Moneylife has just carried a cover page report on Loans going bad by a veteran banking analyst and also a series by a former banker. I now add to them from another angle arising out of my over four decades as a central statutory auditor on the Reserve Bank of India (RBI) panel auditing major banks both domestic and foreign.

It needs to be pointed out that no bank loan goes bad overnight. It takes place over a time. Some of them commence at the sanction and disbursement stages, to begin with the inadequately or badly appraised loans or lines of credits approved by the very top management and pushed up-down to the disbursing branches to proceed without proper documentation, securities and guarantees; just rushed through. When they do go sour initially and bad later, the entire inadequacies crop up but then it is too late to enforce recovery proceedings effectively. This gives the defaulting borrowers an upper hand.


Next are the laxities in monitoring at the branch level—the incipient bad borrowings arise more out of the officials not heeding and acting promptly on the red signals leading to irregularities like the borrowers exceeding drawing powers by not submitting inventory or debtors security statements in time, ultimately resulting in the advances exceeding the sanctioned limits to constant overdrawing, resorting to frequent TODs, bouncing of cheques for want of funds. If only the branch had reported to the controlling authorities the irregularity instead of seeking ratification of allowing it to happen could the warning signals of impending NPA have been resulted by nipping it in the bud by putting an effective brake. Branches tend to take operational irregularities lightly or act routinely only to wake up when the outstandings mount when it is too late.

The RBI panel under its executive director, B Mahapatra while observing that restructuring amounts to an “event of impairment” whether or not its asset classification undergoes a downgrade, has rightly recommended that all loans that are subjected to restructuring should necessarily be classified NPAs as they are in fact sub-standard and not standard which by any stretch of imagination they are not. More particularly when restructuring requires the banks to take a hit by granting concessions like substantial reductions in interest rates, moratorium or elongation of repayment schedule, part waiver of principal and/or interest or converting debt into equity at inflated values a la Kingfisher. There is absolutely no valid justification to make any such distinction that only obfuscates the underlying problem of mounting bad debts! When internationally accepted accounting standards treat restructured advances as impaired they is no reason for Indian banking to deviate from the prudential accounting practices primarily from the transparency perspective.

The RBI’s suggestion of a two-year “regulatory forbearance” for withdrawing the standard classification benefits needs an urgent recall. Notwithstanding this, the banks need to explicitly start recognizing these loans as NPAs as they have suffered considerable diminution in the realizable fair values of the securities assigned to cover them. They have necessarily to be recognized and also provided for entirely in the year of occurrence. It is certainly not correct to defer it to future years when the profits of subsequent years take the hit. The RBI shouldn’t venture into the realm of prudent and accepted international accounting practices by suggesting such deferrals.

The Bank Statutory Auditors, in helping out the bank managements to window-dress their annual accounts to overstate the profits for the year, have, in my considered opinion, wrongly misinterpreted the RBI guidance for deferrals. This is equally applicable to the RBI guidelines for recognizing and providing for the accrued gratuity and pension liability. The bank auditors are under wrong impression that they can get away by merely stating in their auditors’ report—“Without qualifying our opinion/report, we draw attention to Note...” This is no qualification as it does not explicitly state the liability did and does exist on the date of the balance sheet and the not providing for it impacts the profits for the current year. The RBI’s advisory in merely advising them to defer it over a period of time does not absolve them from providing for and disclosing the liability subsisting and also existing. The RBI as the banking regulator and the ICAI as the accounting regulator ought to review this unhealthy practice of window-dressing that only result in overstating the profits. The regulatory forbearance certainly cannot exceed its brief!               

In the two years between March 2009 and March 2011, gross NPAs of our banks shot up from around Rs68,000 crore to Rs94,000 crore. By bringing in the so-called restructuring they have not been wrongly classified as standard—they would have soared from just over Rs60,000 crore to almost Rs1,07,000 crore. The numbers for end-March 2012 are expected to touch a whopping Rs 2,06,500 crore by the banking industry’s restructuring cell.

The Sick Industrial Companies Act (SICA) has been on the statute books for long.  Companies are invariably rendered sick by the promoters who are always hale and hearty. The bankers deal with them with kid gloves by hesitating to make demands on large industrial chronic defaulters. The Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest Act, 2005 (SARAESI), empowers lending banks to seize mortgaged assets of recalcitrant borrowers to realise the best prices without having to resort to court sanction. It is found that it is most commonly applied to small time borrowers like those who have defaulted on EMIs for home loans, vehicles loans, small  time traders that it tantamounts to using a sledge hammer to swat a fly and not recover from the large chronic defaulters.

The big ticket defaulters manage to keep out bank attachment orders by obtaining court stay orders. High profile borrowers like Kingfisher just apply any tactics to keep lending banks at bay. This is simply because the banks and the RBI are found to be speaking with forked tongues. They blow hot and cold at the same time, all the time they are caught pussyfooting—a case of willing-to-push-but-afraid-to-hurt attitude of not touching the big guns, but attaching small owners or traders. Proving right the good old Hindi adage—Hathi janey dega, magar doom pakadke ke baitega—translated letting the elephant pass through only to cling on to its tail.

The standard of toughness of recovery proceedings are strong with small retail borrowers where the flat and vehicle are attached with ease. The bank attitude generally is in keeping with the refrain that when one small entity borrows a couple of lakhs from a bank, the borrower will be in trouble, but when one big ticket borrows crores, it is the bank which is in trouble as the banks  resort to molly coddle the big time borrowers to collect their dues.

To minimize NPAs the RBI to direct the banks to put in place real tough measures of going for the defaulters’ jugular. Insist on personal guarantees and call upon the promoter-directors of public companies also to sign personal guarantees, as is done with private unlisted entities. This is because the promoter clan takes the company’s stakeholders and bankers for a ride after collecting money from initial public offers (IPOs). They should be required to bring in margin money for the lines of credit in hard cash and not by pledging shares of group companies and/or providing their corporate guarantees that are equally dud. They should be asked to cough up not less than 25% of the value of the diminution in the value of securities and/or 10% of the sanctioned limits before even considering any reschedulement in the rescue act. The end use of the borrowed money has to be strictly monitored to ensure there is no misuse thereafter.

The rising NPAs call for drastic strong arm twisting corrective action. The RBI should do well to call upon all banks to furnish a listing of their Top 100 defaulters with a brief on the ages, causes and steps initiated to effect recoveries. The banks and the RBI should make available the listing on their websites along with the progress report on the reduction or otherwise. Most of the defaulters will be found to be big names with strong pull right up to the ministry of finance (MOF) and capable of pulling all strings to keep action at bay. The banks should not stop short of opting for strong coercive proceedings under the securitization laws rather than yield to the mirage of CDR.

If NPAs are not curbed effectively, it will not be long before we in India head the Greek route. The MOF, now under the PM has necessarily to leave the micromanagement of the banking sector to the RBI.

Best assign this task to Dr YV Reddy—the tough acting former RBI governor!

(Nagesh Kini is a Mumbai-based chartered accountant turned activist.)

Girish Pai
1 decade ago
Fabulous article.Right into the details.

We need YV Reddy back. All the spineless folks around are just ruining the economy.

Reddy saved us during 2008 crisis and post his tenure, its all for us to see.

Huge Fiscal Deficit and low growth coupled with lack of governance.

1 decade ago
Excellent article. The top 100 defaulters list should be published in public domain as this defaulters have taken away public money
Ramesh Poapt
1 decade ago
Excellent!Banks adopt window dressing of deposits and under reporting NPAs in a big way,is open secret now!RBI has not free hand.YV Reddy deserves credit for saving India from adverse global meltdown shocks!Though he was also not fully allowed by ex FM...hence Guv had to quit.RBI is always under pressure from Govt/industry lobby/chambers to frame the rate/policy which is short term ineffectvie medicine aka rate cut and reserve requirements of the banks.CMD of SBI openly pursues that.Such things are like uncurable cancer!!May God save banks, PSUs in particular.Pvt banks are far smarter...
1 decade ago
You are absolutely correct. Only one thing I would like to add is that Dr Y V Reddy should be made the finance minister.
nagesh kini
Replied to polyvin comment 1 decade ago
It'll surely be a great day for India if Dr. Reddy is assigned the MOF. But up there the one who is no-nonsense has no say only yes-men!
We are in dire need of someone radical to pull us out of the mess that Pranobda under the benign eye of Man Mohan has landed India into.Sooner the better.
Before we go the PIGS - Portugese, Italy, Greece and Spanish way! God help us!
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