When loans turn sour

The sub-par performance of banks is mainly due to the alarming increase in non-performing assets. The costs and write-offs arising from NPAs impact the banks' bottomlines.

During the first quarter of the ongoing fiscal, the financial performance of banks, especially the public sector banks (PSB), has been lacklustre. Banks have taken a hammering on several fronts, including profits, which have shrunk in the case of several banks, including the State Bank of India.

The sub-par performance has been attributed to a variety of factors. The main culprit has been the alarming increase in non-performing assets (NPAs). Here are the major challenges facing banks on the NPA front.


Once an account is classified as a NPA, banks cannot recognise interest from it. Further, interest debited during the previous period and not collected yet will have to be reversed. This will dent profits for the current period.

The reduction in interest will also affect the net interest income (NII) and net interest margin (NIM). Substantial provisions will have to be made for this impact from the current period's profit. This will again have an effect on the net profits and result in lower return on assets (ROAs).

The maintenance expenses on such accounts include recovery charges, legal charges, and inspection charges. Expenses towards insurance and security of assets will also have to be met by the bank. These charges can be recovered only during final recovery. This amount is often insufficient to cover the principal and interest, let alone the above charges.

WHY ARE NPAs rising?

During the financial crisis in 2008-2009, various stimulus packages were announced by the Government and the Reserve Bank of India (RBI) to turn around ailing industries. These included restructuring of impaired assets along with interest and concessions held by banks.

During this period, banks resorted to restructuring a large number of impaired assets and retaining them as ‘performing assets'. The restructuring programme was based on financial projections which failed in most cases. These accounts may now have to be classified as NPAs.

A few accounts have been technically-classified as NPAs because of delays in commencement of commercial production despite interest and instalments being paid. The delays have been attributed to cost- and time- overruns.

A large number of educational loans are showing signs of going sour. Many of these loans, especially those below Rs 4 lakh, are also now turning into NPAs. Norms for granting such loans are minimal with any student gaining admission at a recognised institute qualifying for a loan.

As per Central Government directives, no security or margin is to be insisted upon. Banks are also unable to obtain personal guarantees from parents in the event of students being majors. This may result in defaults, given that banks have no security to fall back on.


At the point of sanctioning personal loans such as housing loans, vehicle loans, and so on, the repayment capacity of the borrower is assessed. Equated monthly instalments (EMIs) for such loans are calculated using the prevailing rate of interest. These EMIs increase with rising interest rates. Borrowers who are unable to service the account may become NPAs.

The massive write-offs in agricultural loans announced a couple of years ago by the Government have resulted in severe difficulties in recovering loans from borrowers in the agricultural segment.

These borrowers may now expect another round of write-offs. Subsidy-linked government sponsored loans are often target-oriented without any security. In most cases, the projects are unviable and the loans turn NPAs.

The costs and write-offs arising from loans going bad are not restricted to agricultural loans or subsidy-linked government-sponsored loans. There is a substantial impact on the bank's bottom line when accounts of large corporate bodies turn into NPAs.

The reasons for such accounts becoming NPAs include lack of orders, cancellation of orders, inability to achieve projections, labour problems, and so on.


With the passing of the ‘Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest ACT 2002' (SARFAESI), it was thought that recovery of dues by enforcement of security would become a lot easier. However, since inception, the Act has become a subject matter of litigation. Bankers now face a few problems in recovering dues through the sale of securities.

Generally, security of immovable properties is created by equitable mortgage. This is done by deposit of original title deeds with the bank. These do not find a place in the Encumbrance certificate issued by the concerned sub-registrar.

It was also thought that the property cannot be further alienated or sold without production of the original title deeds. But, in quite a few cases, bankers, when they try to enforce the security, find that the property has been sold, with sellers claiming that the original title deeds have been lost.

At the time of granting a loan, the valuation of the security is assessed by a valuer on the bank's panel. However, at the time of enforcing the security, a fresh valuation is taken to arrive at the reserve price. Oddly enough, this value is much less than the initial panel estimate. Clearly, the value has been inflated at the time of sanction to suit the needs of the borrower.


In a few cases, when branch officials go to inspect the property prior to sale, they find it is either non-existent or belongs to someone else. On investigation, it is found that either the title deeds are forged or the same property is mortgaged to multiple financiers by creating multiple title deeds.

Complications also arise when the share of one person in a property jointly owned by more than one person is mortgaged to the Bank, it is impossible to sell part of the property. Politically influential borrowers use coercive means to prevent prospective buyers from participating in auctions.

The borrower invariably comes up with frivolous objections when served an initial notice under SARFAESI, which gives them 60 days time to pay up the dues.

This is especially the case when the property mortgaged is that of the guarantor. The guarantors claim that their signatures in the mortgage documents are forged.

In certain cases, they claim to have signed the documents without realising the implications as they were misled by the borrower or the banker. This often leads to prolonged litigation.

In the case of large consortium advances, the position is more complicated. While the fixed assets are under first charge to the term lenders, the working-capital bankers hold second charge over the fixed assets and first charge over the current assets.

In the case of companies incurring losses, the accumulated losses would have generally eroded the current assets. It would be practically impossible to collect these receivables in the case of a company in distress.

(The author is a former Deputy General Manager of State Bank of Mysore and State Bank of Travancore.)

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