The high level of NPAs in banks and financial institutions has been a matter of grave concern to the public as bank credit is the catalyst to the economic growth of the country and any bottleneck in the smooth flow of credit, one cause for which is the mounting NPAs, is bound to create adverse repercussions in the economy. NPAs are not therefore the concern of only lenders. I consider that forum like this, comprising of representatives of a major section of the beneficiaries of the financial system, should equally get concerned in a serious way on what they can do to address the gravity of the NPA problem of banks. I would rather urge them to lend a helping hand in the ongoing efforts of banks, and financial institutions to recover bad debts and arrest fresh accretions of NPAs.

The prudential norms on income recognition, asset classification and provisioning thereon, are implemented from the financial year 1992-93, as per the recommendation of the Committee on the Financial System (Narasimham Committee I). These norms have brought in quantification and objectivity into the assessment and provisioning for NPAs. We at the central bank constantly endeavour to ensure that our prescriptions in this regard are close to international norms. We are neither strict nor lax but just correct in tune with our needs and capabilities.

• Income should not be recognised on NPAs on accrual basis but should be booked only when it is actually received in respect of such accounts.

• An asset is considered as "non-performing" if interest or installments of principal due remain unpaid for more than 180 days (the lag would get reduced to 90 days from March 31, 2004 to conform to international norms). Any NPA would migrate from sub-standard to doubtful category after 18 months (as against 12 months under international norms). It would get classified as loss asset if it is irrecoverable or only marginally collectible.

• The banks should make full provision for loss assets, 100 per cent of the unsecured portion of the doubtful asset plus 20 to 50 per cent of the secured portion (depending on the period for which the account is doubtful), and a general 10% (it is 20 per cent under international norms) of the outstanding balance in respect of sub-standard assets.

Detailed guidelines have been issued by RBI in October 2000 on valuation and provisioning for investment portfolio including credit substitutes.

The efficiency of a bank is not always reflected only by the size of its balance sheet but by the level of return on its assets. NPAs do not generate interest income for the banks, but at the same time banks are required to make provisions for such NPAs from their current profits.

NPAs have a deleterious effect on the return on assets in several ways �

• They erode current profits through provisioning requirements

• They result in reduced interest income

• They require higher provisioning requirements affecting profits and accretion to capital funds and capacity to increase good quality risk assets in future, and

• They limit recycling of funds, set in asset-liability mismatches, etc.

There is at times a tendency among some of the banks to understate the level of NPAs in order to reduce the provisioning and boost up bottom lines. It would only postpone the doomsday effect as happened in some of the banks with disastrous consequences, like getting branded as weak and losing credibility internationally, besides subjecting the senior management to vigilance and CBI process.

In the context of crippling effect on a bank�s operations in all spheres, asset quality has been placed as one of the most important parameters in the measurement of a bank�s performance under the CAMELS supervisory rating system of RBI.Movement of NPAs over the years

A glance through the statistics on the movement of NPAs of public sector banks since introduction of prudential norms in 1992-1993 will help us to understand the extent to which the public sector banks have made progress in reducing their NPA levels.

The level of gross and net NPAs has been sliding down over the years. Gross NPA had come down from 23.18% in 1992-93 to 12.40% in 2000-01. Net NPA also moved down from 14.46% in 1993-94 to 6.74% in 2000-01. Still the NPA level can be considered of staggering magnitude in absolute terms costing the public sector banks more than Rs.5000 crores annually by way of loss of interest income, besides servicing and litigation costs. To be fair, I have to state that a major portion of the NPAs was a legacy of the pre-prudential days, when banks were accounting for interest as income on accrual basis even when the underlying advances were not performing.

It will be interesting to have a look at the movement of NPAs (gross and net), as a percentage of advances, group-wise over the last four years. This will give an idea of where banks, as different groups, stand in regard to their NPAs.

Note: Figures in parenthesis denote percentage of net NPAs to net advances It may be observed that the malady of high level of NPAs eroding the profitability of banks is not confined to public sector banks alone, but it is equally present in the private sector banks too. While some of the foreign banks loan portfolio had been affected by a few large accounts turning NPA, it is a matter of concern that some of the new private sector banks which started off on a clean slate had acquired so quickly such a large level of NPAs.

The net NPAs, i.e., that portion of NPAs which is not provided for, pose a major concern for solvency of the bank. To the credit of the Indian banking system's ability to provide for loan losses over a period, though not fully, the level of unprovided for NPAs i.e. net NPAs in public sector banks has been continuously declining from 14.46% in 1993-94 to 6.74% in 2000-01. This is still not at a level of comfort and it must be noted that the percentage of net NPAs to net advances in developed countries is around 2%.

As on 31 March 2001 public sector banks together held provisions at 42.83% of gross NPAs. Only 5 banks had provisioning levels to gross NPAs at more than 50 percent as on that date. Provisions held by private banks was at 35%of gross NPAs and as many as 19 old and 6 new private sector banks had less than 50 per cent provisioning. RBI has been advocating in various forums the need for banks building up provisions upto at least a level of 50% of the gross NPAs at the earliest. I would like to mention that RBI during this year had viewed with disfavour cases of banks which proposed to increase dividend levels without reaching a provisioning level of 50 per cent of gross NPAs and would continue the policy till the provisioning levels improve.