Incidence and impact of directed lending to stock of NPAs

In all forums of interactions the global multilateral institutions and rating agencies had with RBI and the Government, directed lending concept gets quoted as an important attribute and a contributory factor for the build up of NPAs in banks in India. It is a different matter that RBI and the Government are accused of soft attitude towards banks which do not fulfill the prescribed targets for priority sector lending, particularly agriculture and small scale sector. To put matters on a proper perspective, I thought I should share some information regarding the contribution by various segments of borrowers to the NPA stock of public sector banks. The picture in the following table as on March 31, 2001, I am sure, is self-revealing.

Recovery of NPAs under priority sector advances particularly to agriculture and small-scale industries is sometimes hampered by externalities. Further, such NPAs are also spread over a large number of accounts and for small amounts. However, one fails to understand the reluctance of large borrowers to honour their repayment obligations. In many cases, failure of banks to take effective action against some of the defaulting large corporate borrowers was also noticed. This is a factor which prompted the Hon�ble Finance Minister in his recent meeting with CMDs of public sector banks to set a time frame for filing suits against such borrowers to facilitate public disclosure of defaults by big borrowers in the banking system. Recovery of dues by banks is directly related to the performance of the borrowal unit/industrial segments. An internal study conducted by RBI shows that in the order of prominence, the following factors contribute to NPAs.

• diversion of funds for

• expansion / diversification / modernization

• taking up new projects

• helping/promoting associate concerns

• time/cost overrun during the project implementation stage

• business (product, marketing, etc.) failure,

• inefficient management,

• strained labour relations,

• inappropriate technology/technical problems,

• product obsolescence, etc.

• recession,

• non-payment in other countries

• inputs/power shortage,

• price escalation,

• accidents, and natural calamities, etc.

• changes in government policies in excise/import duties, pollution control orders, etc.,

• Contribution to NPAs by factors like siphoning off funds thorough fraud/misappropriation was less significant in comparison with other factors.

• Incidence of NPAs on account of deficiencies on the part of banks such as delay in sanction and disbursement of funds whereby borrowing units are starved of funds when in need, and delay in settlement of payments/subsidies by the Government bodies was on the low side in proportion to other factors.

• Lack of effective co-ordination between banks and financial institutions in respect of large value projects does contribute to the emergence of NPAs even at the implementation stage.

RBI had, in February 2000,drawn up certain ground rules in this regard in consultation with banks, financial institutions and IBA and circulated the same among banks and financial institutions for implementation.

Susceptibility of the sanctioning authorities to external pressure, failings of the CEOs and the ineffectiveness of the Board to check his ways also contributed in no small measure to the unusual build up of NPAs in some of the banks.

One of the most prominent causes for NPAs, as often observed by RBI Inspectors, is the slackness on the part of the credit management staff in their follow up to detect and prevent diversion of funds in the post-disbursement stage. The controversy as to who should be held responsible for diversion of funds � banks or borrowers � may not get settled and is not that material for recovery of NPAs. From the RBI side, I would like to stress that borrowers should, in the interest of the viability of the banking system on which they are dependent, resist all temptations to divert bank funds for uses other than for which they are sanctioned. Banks too on their part should be vigilant to detect and prevent diversion of funds as any failure in this front is a potential source of NPAs.

Supervisory action that may arise on account of high level of NPAs

One of the trigger points in the proposed Prompt Corrective Action (PCA) mechanism [which was widely circulated by RBI through the public domain] is the level of net NPAs. When the trigger point under the mechanism is activated by the performance of a bank, the mandatory actions would follow by way of restriction on expansion of risk-weighted assets, submission and implementation of capital restoration plan, prior approval of RBI for opening of new branches and new lines of business, paying off costly deposits and special drive to reduce the stock of NPAs, review of loan policy, etc.

The most important business implication of the NPAs is that it leads to the credit risk management assuming priority over other aspects of bank's functioning. The bank�s whole machinery would thus be pre-occupied with recovery procedures rather than concentrating on expanding business.

As already mentioned earlier, a bank with high level of NPAs would be forced to incur carrying costs on a non-income yielding assets. Other consequences would be reduction in interest income, high level of provisioning, stress on profitability and capital adequacy, gradual decline in ability to meet steady increase in cost, increased pressure on net interest margin (NIM) thereby reducing competitiveness, steady erosion of capital resources and increased difficulty in augmenting capital resources. The lesser appreciated implications are reputational risks arising out of greater disclosures on quantum and movement of NPAs, provisions etc. The non-quantifiable implications can be psychological like �play safe� attitude and risk aversion, lower morale and disinclination to take decisions at all levels of staff in the bank.