EARLY WARNING

SIGNALS
(INCLUDING SMA and
RFA )

PUNEETA CHUGH
MCOM 2
5817
 INTRODUCTION
• MEANING - A non performing asset (NPA) refers to a classification for
loans on the books of financial institutions that are in default or are in
arrears on scheduled payments of principal or interest. In most cases,
debt is classified as nonperforming when loan payments have not been
made for a period of 90 days.
• No loans turn NPA overnight. It is generally a prolonged affair. The failure
of the banks to notice the warning signals lead to repayment problems or
potential cases of NPA.
• The early warning signals are those which clearly indicates or show some
signs of credit deterioration in the loan account. They indicate the
potential problems involved in the accounts so that remedial action can
be initiated immediately.
 CLASSIFICATION OF EARLY WARNING
SIGNALS

EARLY WARNING
SIGNALS

FINANCIAL OPERATIONAL BANKING MANAGERIAL EXTERNAL OTHERS

 FINANCIAL WARNING SIGNALS
• Default in repayment.
• Continuous irregularity in the account.
• Devolvement of LC or invocation of guarantees.
• Deterioration in working capital position or in
liquidity.
• Declining sales compared to previous period
• Substantial increase in long term debts.
• Raising sales but falling profits.
• Incurring operating losses or net losses.
• Raising level of bad debt losses.
 OPERATIONAL WARNING SIGNALS
• Underutilisation of plant capacity
• Non payments of electricity, wages etc
• Frequent labour problems
• Poor diversification and frequent
changes in plan for expansion or
diversification or modernization.
• Delayed or missed employee payrolls.
• Evidence of overstocking and aged
inventory.
• Loss of important customers
MANAGERIAL WARNING SIGNALS
• Diversion of funds and poor financial controls.
• Lack of cooperation from key personnel.
• Change in ,management or ownership pattern
or key personnel.
• Undertaking of undue risks.
• Fudging of financial statements.
 BANKING WARNING SIGNALS
• Frequent request for further loans
• Delays in servicing of interest
• Reduction of operations in the account or reduction in bank
balances.
• Breaching the limit of operating loans; for example, a
sudden overdraft without any business logic.
• Opening of accounts with other banks.
• Dishonour of cheques or return of bills sent for collection
• Not routing sales transactions through the account.
• Delays in submitting stock statements and other data or
non submission of periodical statement.
• Frequent excesses in the account.
 EXTERNAL WARNING SIGNALS
• Economic recession.
• Introduction of new
technology
• Changes in government
policies
• Emergence of new
competition.
• Natural calamities.
• Weakening of industry
characterstics.
 OTHER INDICATORS

OTHER
INDICATORS

BEHAVIOUR INDUSTRY
GEOGRAPHIC PERCEPTION
 BEHAVIOURAL INDICATORS

• Any attempt at deception / misrepresentation of facts.

• Regular and consistent attempts at delaying financial reporting
requirements; unwillingness to respond to various communications.
• Avoiding direct and complete responses to specific questions; bluffing
by answering a question with a question.
• Evading requests or providing irrelevant information to a request;
excessive delays in responding to a request for no valid reason.
• Creating fake or shell entities for the purpose of misappropriating
goods and services.
• Transferring assets without any concrete business reason to back up
the decision; disposing of the asset at less than the fair value.
 GEOGRAPHIC INDICATORS
• Exchange rate
devaluation.
• Continuous decline in
economic growth in the
region
• Steady growth in money
laundering. Country risks
due to unfavorable
political environment
 INDUSTRY INDICATORS
• Increase in adverse industry regulations, such as a
ban on exports.
• Inability to control increasing costs and rising
input prices.
• Changing customer behavior with respect to the
business segment.
 PERCEPTION INDICATORS
• A decrease in awareness of
the client’s brand and/or
logo.
• Less positive media
exposure.
• Deteriorating relationships.
• Negative price perception in
the eyes of end customers
 FRAMEWORK FOR DEALING WITH
LOAN FRAUDS
• Objective of the framework
• Objective of this framework is to direct the focus of banks on the aspects
relating to prevention, early detection, prompt reporting to the RBI (for
system level aggregation, monitoring & dissemination) and the
investigative agencies (for instituting criminal proceedings against the
fraudulent borrowers) and timely initiation of the staff accountability
proceedings (for determining negligence or connivance, if any) while
ensuring that the normal conduct of business of the banks and their risk
taking ability is not adversely impacted and no new and onerous
responsibilities are placed on the banks.
 Early Warning Signals (EWS) and Red
Flagged Accounts (RFA)
• A RFA is one where a suspicion of fraudulent activity is thrown up by the
presence of one or more Early Warning Signals (EWS).
• These signals in a loan account should immediately put the bank on alert
regarding a weakness or wrong doing which may ultimately turn out to be
fraudulent.
• All accounts beyond Rs.500 million classified as RFA or ‘Frauds’ must also be
reported on the CRILC( Central repository of information on large credits) data
platform together with the dates on which the accounts were classified as
such. The CRILC data platform is being enhanced to provide this capability by
June 1, 2015.
• The modalities for monitoring of loan frauds below Rs.500 million threshold is
left to the discretion of banks. However, banks may continue to report all
identified accounts to CFMC( central fraud monitoring cell), RBI as per the
existing cut-offs.
• The tracking of EWS in loan accounts should not be seen as an additional task
but must be integrated with the credit monitoring process in the bank so that
it becomes a continuous activity.
 Some Early Warning signals which should alert the bank officials about some
wrongdoings in the loan accounts which may turn out to be fraudulent (APPENDIX I)

• Default in payment to the banks/ sundry debtors and other statutory bodies,
etc., bouncing of the high value cheques
• Raid by Income tax /sales tax/ central excise duty officials
• Frequent change in the scope of the project to be undertaken by the borrower
• Under insured or over insured inventory
• Invoices devoid of TAN ( Tax Deduction and Collection Account Number) and
other details
• Dispute on title of the collateral securities
• Costing of the project which is in wide variance with standard cost of installation
of the project
• Funds coming from other banks to liquidate the outstanding loan amount
• Foreign bills remaining outstanding for a long time and tendency for bills to
remain overdue
• Onerous clause in issue of BG/LC/standby letters of credit
• In merchanting trade, import leg not revealed to the bank
• Request received from the borrower to postpone the inspection of the godown
for flimsy reasons
• Delay observed in payment of outstanding dues
• Financing the unit far away from the branch
• Claims not acknowledged as debt high
• Frequent invocation of BGs and devolvement of LCs
• Funding of the interest by sanctioning additional facilities
• Same collateral charged to a number of lenders
• Concealment of certain vital documents like master agreement, insurance
coverage
• Floating front / associate companies by investing borrowed money
• Reduction in the stake of promoter / director
• Resignation of the key personnel and frequent changes in the management
• Substantial increase in unbilled revenue year after year.
• Large number of transactions with inter-connected companies and large
outstanding from such companies.
• Significant movements in inventory, disproportionately higher than the growth in
turnover.
• Significant movements in receivables, disproportionately higher than the growth
in turnover and/or increase in ageing of the receivables.
• Disproportionate increase in other current assets.
• Significant increase in working capital borrowing as percentage of turnover.
• Critical issues highlighted in the stock audit report.
• Increase in Fixed Assets, without corresponding increase in turnover (when
project is implemented).
• Increase in borrowings, despite huge cash and cash equivalents in the borrower’s
balance sheet.
• Liabilities appearing in ROC search report, not reported by
the borrower in its annual report.
• Substantial related party transactions.
• Material discrepancies in the annual report.
• Significant inconsistencies within the annual report
(between various sections).
• Poor disclosure of materially adverse information and no
qualification by the statutory auditors.
• Frequent change in accounting period and/or accounting
policies.
• Frequent request for general purpose loans.
• Movement of an account from one bank to another.
• Frequent ad hoc sanctions.
• Not routing of sales proceeds through bank
• LCs issued for local trade / related party transactions
• Filing Complaints with Law Enforcement Agencies
• Banks are required to lodge the complaint with the law enforcement
agencies immediately on detection of fraud.
• delays may result in the loss of relevant ‘relied upon’ documents, non-
availability of witnesses etc.
• Penal measures for fraudulent borrowers
• In particular, borrowers who have defaulted and have also committed a
fraud in the account would be debarred from availing bank finance from
Scheduled Commercial Banks, Development Financial Institutions,
Government owned NBFCs, Investment Institutions, etc., for a period of
five years from the date of full payment of the defrauded amount.
• No compromise settlement involving a fraudulent borrower is allowed
unless the conditions stipulate
• Central Fraud Registry
The Reserve Bank is in the process of designing a Central Fraud Registry, a
centralised searchable database, which can be accessed by banks.
 WHAT IS SPECIAL MENTION
ACCOUNTS (SMA)?
• The classification of Special Mention Accounts
(SMA) was introduced by the RBI in 2014, to
identify those accounts that has the potential to
become an NPA/Stressed Asset.
• Logic of such a classification is because some
accounts may turn NPA soon.
• Here, an early identification will help to tackle the
problem better.
• Special Mention Accounts are those
assets/accounts that shows symptoms of bad
asset quality in the first 90 days itself
 WHAT IS THE DIFFERENCE BETWEEN
NPA AND SMA?
A non performing asset (NPA)
refers to a classification for loans
on the books of financial
institutions that are in default or
are in arrears on
scheduled payments of principal or
interest. In most cases, debt is
classified as nonperforming
when loan payments have not been
made for a period of 90 days or
more.
•On the other hand, the worst type
of special mention account (SMA –
2) has less than 90 days’ duration.
• The Special Mention Account
identification is an effort for early
stress discovery of bank loans. It
was introduced as a corrective
action plan to contain stress.
 CLASSIFICATION OF SPECIAL
MENTION ACCOUNTS
SMA Sub Category Classification basis

SMA – NF Non-financial (NF) signals of stress

SMA-0 Principal or interest payment not overdue for more than 30

days but account showing signs of incipient stress, Delay of
90 days or more in (a) submission of stock statement /
other stipulated operating control statements or (b) credit
monitoring or financial statements or (c) non-renewal of
facilities based on audited financials.

SMA- 1 Principal or interest payment overdue between 31-60days.

SMA – 2 Principal or interest payment overdue between 61-90 days.

 RECENT NEWS
The Reserve Bank of India (RBI) has sent commercial banks a second
list of at least 26 defaulters with which it wants creditors to start the
process of debt resolution before initiating bankruptcy proceedings.
• These are accounts where 60% of the outstanding amount was
classified as non-performing on the books of banks as of 30 June.
• Videocon Industries Ltd and Jai prakash Associates Ltd (JAL) are the
two large companies among the list of 26 defaulters, accounting for
over Rs1 trillion of debt.
• The Reserve Bank of India (RBI) sought to address potentially about
one fourth of the Rs 10 lakh-crore non-performing assets (NPAs) on the
books of local lenders, mandating that a dozen such accounts be taken
to the bankruptcy courts.
• Although the RBI didn't name any defaulter, bankers say borrowers
such as Bhushan Steel, Essar Steel, Lanco, and Alok Textiles may be
the first set of companies facing proceedings under stringent recovery
laws.
•