There was a news item about PSU banks being asked by the Government to conserve capital through cost cutting without compromising on the growth on the loan portfolio! There are reports that the Government wants these banks to grow at the rate of 30 per cent even when they are struggling at 20 per cent. Even at those rates, some banks do not meet the capital adequacy norms!

In normal times, such a statement should have set the strategists thinking with a clear frame of mind. That luxury is currently not available. The requirement should be viewed in the backdrop of the financial performance of the banking sector for the second quarter ended September 2011. What is however very intriguing is the fact that the results have shown quite a bit of a variation. The growth in the profits has been quite large from a negative growth of 20 per cent to positive growth of 22 per cent! The performance during the third quarter could potentially be even more volatile with a negative bias.

Unfortunately the data could potentially be misleading as banks have been mandated by the RBI to provide for Non Performing Assets based on system generated reports! The past errors, attributed conveniently to “human errors” are biting the banks when the situation is already bad! There increase in the NPAs too must be attributed to the macro economic situation where the economy has been experiencing a serious slowdown.

This brings the discussion to what this means to the banks. The problem of the NPAs has to be dealt with in from preventive as well as a curative perspective.

preventive perspective

Let us start with the preventive perspective. The current practice of recognising an NPA based on non-servicing of interest or adhering to repayment obligations for 90 days is the best we can get to. But then sickness of business is no different from that of human beings. The golden hour is extremely critical and important. Accordingly to medical experts the chances of survival go up significantly when the patient is taken under professional medical care in the first hour! A financial emergency also warrants the intervention of business doctors at the earliest! There is a huge opportunity as most banks in India are already operating under the Core Banking System (CBS) which means that the data of the individual branches is already residing at the central data centre. This gives a huge opportunity for the banks to invest in data mining and analysis. Predictive analytical tools are the order of the day. Credit companies did that and have reaped the benefits of proactive profiling and monitoring. It is not to suggest that this is not happening but the opportunities are much more. Banks still operate under the system of determining limits based on the financial projections submitted at the time of the sanction.

While this is good measure of the credit requirements, it is not adequate for the purposes of monitoring the health of the account. The credit needs would have to be a function of the velocity of the business and cash flows. The data is all there in the system and all that is needed to use appropriate tools or algorithms to throw up exceptions for further investigations. Even past data of the same organisation could give some good indicators. All these are possible only through automated tools and it would be inappropriate to expect the staff to undertake such a task.

curative perspective

Finally the curative part, the current model of the asset reconstruction companies has not met their objective. It has to be more proactive and much earlier than it currently undertaken. Post the asset having become an NPA, the role of the asset reconstruction companies (ARC) comes into the focus. The current role of the ARCs is more in the nature of asset stripping companies. There is a huge business case for such an NPA being handed over to professional turnaround specialists who step in to nurse the companies back to health. There are number of cases where assets have become an NPA for a couple of bad management decisions or uncontrollable external business or regulatory environment.

private equity funds

There is also an opportunity for private equity funds to step into the process to ensure that the assets are put to better use.

These funds are capable of bringing into the necessary management expertise as well as explore the possibility tagging these companies along with their existing investee companies to bring about greater synergies. The existing guidelines in the Foreign Direct Investment may require a bit of tweaking even though it already provides for some concessions in respect of investments made in sick units.

To do this the regulatory framework and the legal system will have a greater role to play. The existing practices like the Debt Recovery Tribunal or the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act have not met the needs of the financial community. The wilful defaulters have exploited the delays in the legal system to their advantage. Any new methodology would definitely be a problem to implement. However, the banks, ARC and private equity funds could together work with the borrowers to voluntarily go into the process.

(The author is Director, Value Added Corporate Services P Ltd, Chennai.)

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