Amidst the reams of discussion and data put out in the public domain on non-performing assets (NPAs), there has been almost no serious attempt to understand its root causes.

To the uninitiated, a bank loan becomes an NPA if the borrower doesn’t pay the interest or instalment even after 90 days from the due date. NPAs are a double whammy — banks no longer can earn interest income from such accounts, and they have to make a certain amount of provision from their profit for those accounts.

The NPAs are defined and classified under the Reserve Bank’s Income Recognition and Asset Classification (IRAC) norms.

Internal and external reasons While examining the surging bad debts of public sector banks in particular, what is generally overlooked are the range of internal and external factors causing it.

Once this is appreciated, it would become evident that a more multi-pronged approach is called for.

The solutions arising out of the IRAC norms are not equal to the complexity of the problem at hand.

The internal reasons for loan default may include: serious illness or death of the promoter, managing partner or key persons in management; mismanagement of funds or inventory; siphoning off funds; and, importantly, diversion of working capital funds.

Again, the diversion of funds may be external or internal. External diversion refers to ‘misuse’ of the working capital provided by the bank to invest in associate firms or to buy properties not relevant to the business concerned.

This is deemed a case of fraud. There is a tendency to view all big-ticket NPAs as results of wilful default or deliberate diversion of funds. This may not be the case. There are not many Mallyas in our system!

Internal diversion refers to the working capital funds being used to buy capital goods such as machinery.

The external reasons for a loan to become an NPA include: an unexpected delay in getting raw materials; unexpected fall in the order book; natural calamities; damage to due fire; and, importantly, very subdued growth in the economy.

While a close monitoring of loan books can provide signals on loans slipping into NPAs if they are on account of internal reasons, it would be beyond the control of banks in the case of NPAs arising due to external factors. Again, external factors sometimes produce systemic effects.

For example, several small-scale units work on sub-contracts and make supplies to big companies. If these giants fail to pay these small firms or even prolong payments, it will hit the loan accounts of dependent firms.

So, banks may be permitted to restructure or reschedule its payment terms at least once during the currency of the loan, if it is stressed on account of any of these reasons.

Blanket rule Unfortunately, the RBI does not buy this logic; it permits rescheduling of such a loan ‘only if’ the bank declares the loan an NPA. There could be a multitude of reasons at work for a loan slipping into an NPA.

Therefore, addressing this menace is not a simple affair, and no single solution will resolve this knotty issue.

To identify and mark an account as NPA, which is a system-driven process in all banks, there is a standard formula. The yardstick is the same for all loans — big or small; personal or trade; or a loan to a manufacturer; all loans, except farm loans, are equal in the eyes of the IRAC norms.

That’s one of the problems. The IRAC norms are similar to the earlier versions of the Basel rules. In 1992, the Basel Accord was introduced to strengthen the capital base of banks. Later in 2003, the improved version of the same was brought into force, namely Basel II.

Now Basel III is in vogue. In Basel I, the risk weights were predetermined or fixed for the credit portfolio of banks. In other words, the view under Basel I — ‘one cap fits for all’ — was no longer felt workable and hence Basel II came into being.

Strikingly, the IRAC norms are also similar in nature and they are uniformly applicable to all loans and advances. To make them more relevant, they need to be modified.

The RBI or the Government must constitute a core committee to re-examine the IRAC norms see and how best they could be made more dynamic, workable and realistic.

A panel for change The committee must have at least two or three senior bankers who have rich, varied and hands-on experience in the area of credit dispensation.

The terms of reference of the committee could be to review and revise the existing NPA norms and make them flexible; to suggest how and where restructuring could be allowed without lowering the status of the asset; to suggest how and where haircuts could be done while making provisions; and, to look into the level of freedom top management of banks can enjoy while managing stressed assets without resorting to “ever-greening” of accounts.

Such a strategy would provide a great relief to banks in the matter of handling stressed assets. More importantly, they will shift their focus to credit growth by shedding their abhorrence towards lending to new projects.

As a result, we may all be able to witness a clear boom in the economy.

The writer is Director, City Union Bank. The views are personal

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