Genesis of NPAs

Srinivas Dindi | Updated on January 17, 2018 Published on July 10, 2016


Cash flows were not adequately assessed

Recently, there has been increased reference to “skeletons in the banks’ cupboards” in the context of the spurt in NPAs. This is despite the finance minister making it clear that the reference to skeleton should only be made in the context of fraud. But the question that remains unanswered is: Why has there been such a sudden spurt in NPAs despite scrutiny of the loan book by internal auditors and external auditors on the panel of ICAI and Regulators under Sec 35 of RBI Act, from time to time?

All along, the performing status of loan assets in India is more based on record of recovery. Though visibility and adequacy of future cash flows are looked at while appraising a loan, in a case of shortfall in such cash flows all are content as long as the repayment obligations are met.

This could be either through further equity infusion by the promoter which is considered the best option, or through fresh borrowings raised by group companies at the cost of increased debt at a group level.

Rather, for the first time, a serious thought was given in the Asset Quality Review (AQR) to look at underlying cash flows, and if they are short, to call it a stressed asset.

Further, due to overall economic slowdown and policy paralysis, loan obligations were being met on the 89th day. The particulars of all such Special Mention Accounts (SMAs) were kept in the public domain through mandated reporting to the Central Repository of Information on Large Credits (CRILC) data, a well thought out mechanism of the RBI.

The increase in NPAs is now being felt; this is because banks’ profits have dwindled due to increased provisions in the event of loans slipping from SMA category to NPA. In cases where turnaround possibilities looked good, banks actively considered increasing the cover period of receivables of companies, private parties and government, up to 180 and 360 days, respectively, as against banks’ own NPA norm of 90 days.

However, with no improvement in industry cycles, the stress continued and the mismatch between the realisation periods of banks and companies further widened, resulting in NPAs.

Promoters who had been moving earth and heaven to meet obligations on the last day could not stretch further. Some would have also taken shelter under the AQR of RBI which is more based on cash-flow visibility.

In the process, borrowings at group companies have also simultaneously gone up resulting in increased debt at the group level. Till recently, preparation of consolidated financial statements (CFS) was not mandatory. Many companies have floated SPVs to hold single assets like road projects.

Appraisals were carried out more based on the cash flows of that single asset rather than by looking at the group level debt and sufficiency of cash flows at the group level to meet overall debt.

Even if banks had insisted on CFS, unlisted companies would earlier get away, as it was not mandatory as per the statute.

With the Companies Act 2013 making it mandatory to draw up CFS for companies which have subsidiariess / joint ventures, the appraisal standards would now be more meaningful.

To conclude, there is a need to move away from ‘record of recovery’ to ‘adequacy of cash flows’ as the NPA norm and also look at adequacy of cash flows at the group level while assessing funding requirements of subsidiaries and/or associates.

The writer is vice-president of syndications, SBI, US operations, New York. The views are personal

Published on July 10, 2016
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