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Non performing assets

Classification of Assets as Non-Performing

An asset becomes non-performing when it ceases to generate income for the bank. Earlier an asset was considered as non-performing asset (NPA) based on the concept of 'Past Due'. A non performing asset (NPA) was defined as credit in respect of which interest and/ or installment of principal has remained past due for a specific period of time. An amount was considered as past due, when it remained outstanding for 30 days beyond the due date. However, with effect from March 31, 2001 the past due concept has been dispensed with and the period is reckoned from the due date of payment.

Non performing Assets

With a view to moving towards international best practices and to ensure greater transparency, '90 days' overdue norms for identification of NPAs have been made applicable from the year ended March 31, 2004. Thus, a NPA shall be 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 for a period of more than 90 days, in respect of an Overdraft/CC. The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,

Over due and out of order

Any amount due to the bank under any credit facility, if not paid by the due date fixed by the bank becomes overdue An account should be treated as 'out of order' if the outstanding balance remains continuously in excess of the sanctioned limit / drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days or credits are not enough to cover the interest debited during the same period, these accounts should be treated as 'out of order.

Asset Classification
Banks should classify their assets into the following broad groups, viz Standard Assets Sub-standard Assets Doubtful Assets Loss Assets

Standard Assets

Standard Asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset should not be an NPA.

Sub Standard Assets

With effect from March 31, 2005 an asset would be classified as sub-standard if it remained NPA for a period less than or equal to 12 months. In such cases, the current net worth of the borrowers/ guarantors or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full. An asset where the terms of the loan agreement regarding interest and principal have been renegotiated or rescheduled after commencement of production, should be classified as sub-standard and should remain in such category for at least 12 months of satisfactory performance under the renegotiated or rescheduled terms.

Doubtful and loss Assets

With effect from March 31, 2005, an asset is required to be classified as doubtful, if it has remained NPA for more than 12 months. A loan classified as doubtful has all the weaknesses inherent as that classified as sub-standard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. A loss asset is one where loss has been identified by the bank or internal or external auditors or by the RBI inspection but the amount has not been written off, wholly or partly. In other words, such an asset is considered un-collectible.

Provisioning for NPAs

Banks have to keep aside extra funds, called provisioning in banking parlance, for standard assets as well. As per the norms, banks have to make a general provision of 0.40% for all loans and advances except that given towards agriculture and small and medium enterprise (SME) sector. In case of NPAs, provisioning needs to be done as per the NPA category. For substandard loans, a general provisioning of 10% on the total outstanding amount is made if the loan is secured, for unsecured loans the total provisioning that needs to be done is 20% on the outstanding balance.

Recovery and sale of NPAs

Under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, the banks can take legal recourse to recover their dues. If a borrower makes any default in repayment and his account is classified as NPA, then the secured creditor has to issue notice to the borrower giving him 60 days to pay his dues. If the dues are still not paid, the bank can take possession of the assets and can also give it on lease or sell it. A bank can sell NPA from its books to asset reconstruction companies such as ARCIL only if it has remained NPA for at least two years. Such sale can take place only on cash basis. The purchasing bank has to keep the accounts in its books at least for a period of 15 months before it is sold to other banks. The purchased NPA may be classified as 'standard' in the books of the purchasing bank for a period of 90 days from the date of purchase.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act

The legal framework for securitisation in India with the enactment of theThe Securitisation and Reconstruction of Financial Assets And Enforcement of Security Interest Act, 2002. Its purpose is to promote the setting up of asset reconstruction/securitisation companies to take over the Non Performing Assets (NPA) accumulated with the banks and public financial institutions. The Act provides special powers to lenders and securitisation/ asset reconstruction companies, to enable them to take over of assets of borrowers without first resorting to courts.

SARFAESI -Objectives
The Act deals with three aspects. 1. Enforcement of Security Interest by secured creditor (Banks/Financial Institutions) 2. Transfer of non- performing assets to Asset Reconstruction Company, which will then dispose of those assets and realise the proceeds. 3. To provide a legal framework for securitisation of assets.

Securitisation is the process of conversion of existing assets or future cash flows into marketable securities. the conversion of existing assets into marketable securities is known as assetbacked securitisation and the conversion of future cash flows into marketable securities is known as future-flows securitisation. Some of the assets that can be securitised are loans like car loans, housing loans, etc. and future cash flows like ticket sales, credit card payments, car rentals or any other form of future receivables.

Process and Participants

Section 5 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, mandates that only banks and financial institutions can securitise their financial assets. A bank maintains a loan as an asset on its balance sheet and monitors it for collection. Securitization helps in unblocking the funds otherwise locked in loans given.

Bank in this case is the originator. The customer taking loan is the obligor. SPV -a separate entity formed exclusively for the facilitation of the securitisation process and providing funds to the originator. These securities issued by the SPV to the investors and are known as passthrough-certificates (PTCs). The difference between rate of interest payable by the obligor and return promised to the investor investing in PTCs is the servicing fee for the SPV.

The investors can be banks, mutual funds, other financial institutions, government etc. In India only qualified institutional buyers (QIBs) who posses the expertise and the financial muscle to invest in securities market are allowed to invest in PTCs. QIB - Mutual funds, financial institutions (FIs), scheduled commercial banks, insurance companies, provident funds, pension funds, state industrial development corporations etc. The rating agency rates the securitised instruments on the basis of asset quality, and not on the basis of rating of the originator.

The administrator or the servicer is appointed to collect the payments from the obligors. The servicer follows up with the defaulters and uses legal remedies against them. Once assets are securitised, these assets are removed from the bank's books and the money generated through securitisation can be used for other profitable uses, like for giving new loans.

Securitisation also helps banks to sell off their bad loans (NPAs or non performing assets) to asset reconstruction companies (ARCs). ARCs, which are typically publicly/government owned, act as debt aggregators and are engaged in acquiring bad loans from the banks at a discounted price, thereby helping banks to focus on core activities. On acquiring bad loans ARCs restructure them and sell them to other investors as PTCs, thereby freeing the banking system to focus on normal banking activities. Asset Reconstruction Company of India Limited (ARCIL) was the first (till date remains the only ARC) to commence business in India.