Final dissertation llm-rubina muazzam final

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Page 1 of 108 INDIAN BANKS BIG NPA PROBLEM AND DEBT RECOVERY SOLUTIONSA dissertation submitted in partial fulfillment of the requirement for award of the degree of Master of Laws Submitted by: - Under the supervision of: - Name of student: Rubina Muazzam Faculty name: Ms. Vibha Srivastava Roll no. : LS/LM/15/001 Designation: Professor Enrolment no:15SLLALLM4003 School of Law and Legal Affairs Noida International University Gautam Budh Nagar, Uttar Pradesh-India (2015-2016)

Transcript of Final dissertation llm-rubina muazzam final

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“INDIAN BANKS BIG NPA PROBLEM AND DEBT RECOVERY SOLUTIONS”

A dissertation submitted in partial fulfillment of the requirement for award of the

degree of

Master of Laws

Submitted by: - Under the supervision of: -

Name of student: Rubina Muazzam Faculty name: Ms. Vibha Srivastava

Roll no. : LS/LM/15/001 Designation: Professor

Enrolment no:15SLLALLM4003

School of Law and Legal Affairs

Noida International University

Gautam Budh Nagar,

Uttar Pradesh-India

(2015-2016)

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DECLARATION

I, Rubina Muazzam, daughter of Prof. Dr. Mohd. Muazzam hereby declare that the dissertation

on “Indian Banks Big NPA Problem and Debt Recovery Solutions” is original work, and it has

not been submitted, either in part or full, anywhere else for the purpose of, academic or

otherwise.

Date: Name of student: Rubina Muazzam

Roll no.: LS/LM/15/001

Enrolment no.: 15SLLALLM4003

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CERTIFICATE

This is to certify that Ms. Rubina Muazzam who is a bonafide student having enrolment No.

15SLLALLM4003. She is submitting this Dissertation entitled "Indian Banks Big NPA Problem

and Debt Recovery Solutions" for awarding the degree of Master in Laws. She has worked on

the above mentioned topic under my constant supervision and guidance to my entire satisfaction

and her/his dissertation is worthy of consideration for the award of the Degree of Master of

Laws. As this dissertation meets the requirements laid down by School of Law and Legal

Affairs, Noida International University, hence, I recommend this dissertation to be accepted for

evaluation.

Name of Supervisor: Ms. Vibha Srivastava Dr. Pankaj Dwivedi

Designation: Professor Head of Department

School of Law and Legal Affairs School of Law and Legal Affairs

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ACKNOWLEDGEMENT

On the occasion of the submission of this LL.M Dissertation synopsis on topic “Indian Banks Big

NPA Problem and Debt Recovery Solutions”, first of all I humbly pray to almighty God and then

my respected Father and Mother by whose grace this work has been completed. I express my

deep sense of gratitude to Dr. Pankaj Dwivedi, HOD, School of Law, Noida International

University, Noida, whose ideas have always been a source of inspiration for me. His disciplined

approach towards the life has always motivated me to do a work in a very systematic &

organized way within the proper time.

I express my sincere gratitude to the Professor (Dr.) Vikram Singh, the Honorable Pro-

Chancellor, (former DGP Uttar Pradesh), Vice-Chancellor Professor (Dr.) Kumkum Diwan,

Registrar, and Directors of all the schools of the University. They have been a source of

inspiration for me to complete this synopsis. They have been conscious guardian for me. I am

really grateful to them and remain thank full for their guidance.

I express my deep sense gratitude to my supervisor Prof. Ms. Vibha Srivastava School of Law &

Legal Affairs, Noida International University, Noida. She guided me in proper manner by which

it become possible to work on this issue. I am highly thankful to her.

I take this opportunity to express my profound gratitude to all the respected teachers of School

of Law and Legal Affairs. I have no words for the contribution of all my respected teachers and

staff of my University for their consistent suggestions regarding my Dissertation work, which

helped me immensely to undertake a long academic journey. Library staff also deserves my

special gratitude for their kind cooperation.

Last but not least, I am grateful to all my friends, to have been there with me to encourage, to

guide and help me out in the difficult moments of my life both in University and outside, during

the entire course of LLM.

Rubina Muazzam

LS/LM/15/001

15SLLALLM4003

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LIST OF ABBREVIATIONS

ABC: Adjusted Bank Credit

ABS: Asset Backed Securities

AFCs: Assets Financing Companies

ALM: Asset Liability Management

AMC: Asset Management Company

ANBC: Adjusted Net Bank Credit

ARC: Asset Reconstruction Company

BCBS: Basel Committee on Banking Supervision

BFS: Board for Financial Supervision

BIS: Beaureu of international Settlement

CADP: Common area development programme

CAPM: Capital Assets Pricing Model

CAR: Credit Adequate Ratio

CARE: Credit Analysis and Research Ltd

CCF: Credit Conversion Factor

CFSA: Committee on financial sector assessment

CIBIL: Credit Information Bureau Ltd

CLO: Collateralized Loan Obligation

CPs: Commercial Papers

CPC: Civil Procedure Code

CRR: Cash Reserve Ratio

CRAR: Capital Risk Weighted Asset Ratio

CRISIL: Credit Rating Information Service of India Ltd

DDP: Dessert development programme

DEA: Data Envelopment Analysis

DFI: Development Financial Institution

DICGC: Deposit Insurance and credit Guarantee Corporation

DPAP: Draught prone area programme

DRDA: District rural development agency

DRT: Debt Recovery Tribunal

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DRAT: Debt Recovery Applet Tribunal

DGA: Duration Gap Analysis

ECAIs: External Credit Assessment Institutions

ECGC: Export Credit Guarantee Corporation

FDI: Foreign Direct Investment

FI: Financial Institution

GOI: Government of India

GTB: Global Trust Bank

HFC: Housing Finance Company

IRDP: integrated rural development programme

IRAC: Income Recognition and Asset Classification

IRS: Interest rate swaps

KCCS: Kissan Credit Card Scheme

KYC: Know your Customer

LGD: Laws given default

MBS: Mortgaged Backed Securities

MFAL: Marginal farmer’s agricultural labourers

MOU: Memorandum of Understanding

MPBF: Maximum Permissible Bank Finance

MSME: Micro Small and medium enterprise

NABARD: National Bank for Agricultural and Rural Development Bank

NBC: Net Bank Credit

NBFC: Non Banking Financial Companies

NBFI: Non Banking Financial Institution

NC: Narasimham Committee

NGO: Non Governmental Organisation

NHB: National Housing Banks

NPA: Non Performing Asset

OBC: Oriental Bank of Commerce

OPS: Other Priority Sector

OSS: Off-Site Surveillance Software

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OTS: One Time Settlement

PACS: Primary Agricultural Credit Societies

PEO: Programme evaluation Organization

PLR: Prime Lending Rate

PSA: Priority Sector Advances

PSB: Public Sector Bank

PTC: Private Trust Company

PCBs: Primary Cooperative Banks

RFIs: Rural Financial Institutions

RIDF: Rural Infrastructure Development Fund

ROA: Return on Asset

RRB: Regional Rural Bank

SACP: Special Agricultural Credit Plan

SARFAESI: Securitization and reconstruction of financial asset and

Enforcement of Security Interest

SCB: Scheduled Commercial Bank

SEB: Salary Earners’ Bank

SFDA: Small farmer’s development agency

SGSY: Swarna Jayanti Gram Swarozgar Yojna

SHGs: Self Help Groups

SIDBI: Small Industry Development Bank of India

SLR: Statutory liquid Ratio

SME: Small and medium enterprise

SPV: Special Purpose Vehicle

SSI: Small Scale Industry

STCBs: State Cooperative Banks

TAFCUB: Task Force for Cooperative Urban Bank

TGA: Traditional Gap Analysis

UCB: Urban Cooperative Bank

VC: Venture Capital

WPI: Whole Sale Price Index

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TABLE OF CASES: NPA ACCOUNTS

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INDEX

CHAPTER NO. SUBJECT

PAGE NO.

Declaration 2

Certificate 3

Acknowledgement 4

List of Abbreviations 5

Table of Cases 8

Chapter 1 Introduction 13

1.2 Abstract 14

1.3 present scenario 14

1.4 classification of NPA’s 15

1.5 Development and Comparisons of

Banks and Non-Banking Financial

Institution

17

1.6 Non-Banking Financial Company

18

1.7 Cooperative Banking Sector 19

Chapter- 2 Difficulties With The Non-Performing

Assets And Review Of Literature And

Genisis Of Committees.

37

2. Difficulties With The Non-

Performing Assets

38

2.2 Review Of Literature And Genisis

Of Committees

39

2.3 Various Committee Reports – On

Credit

39

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2.4 Various Committee Reports On

NPA

42

2.5. Conclusions

43

Chapter- 3 Comparative Study With Other

Countries And Scope Of The Study

45

3.1 Comparative Study With Other

Countries

46

3.2 The Need for the Study 48

3.3 Statement of the Problem

48

3.4 Objectives of Study 49

3.5 Limitation of the Study 49

3.6 Methodology of the study 49

3.7 Conclusion 50

Chapter- 4 LEGAL FRAME WORK AND

NOTIFICATION

51

4.1 Introduction 52

4.2 Purpose of the Act 52

4.3 The Securitisation and

Reconstruction of Financial Assets and

Enforcement of Security Interest Act,

2002

53

4.4 Debt Recovery 62

4.5 SEBI 71

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Chapter- 5 Solutions to NPA 82

5.1 Steps which cure the disease of

NPAs

83

5.2 Bad loans 84

5.3 present scenario 84

5.4 Comparison/ Charts 87

Chapter- 6 FINDINGS AND CONCLUSIONS

91

6.1 Introductions 92

6.5 Major findings 93

Chapter-7 Suggestion and Recommendations 99

BIBLIOGRAPHY 102

Books

Reports

Articles/ journal

Websites

Case Laws

105

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INTRODUCTION

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INTRODUCTION

1. Brief Introduction:

Banking sector reforms in India has progressed promptly on aspects like interest rate

deregulation, reduction in statutory reserve requirements, prudential norms for interest rates,

asset classification, income recognition and provisioning. But it could not match the pace with

which it was expected to do. The accomplishment of these norms at the execution stages without

restructuring the banking sector as such is creating havoc. This research paper deals with the

problem of having non-performing assets, the reasons for mounting of non-performing assets and

the practices present in other countries for dealing with non-performing assets.

During pre-nationalization period and after independence, the banking sector remained in private

hands Large industries who had their control in the management of the banks were utilizing

major portion of financial resources of the banking system and as a result low priority was

accorded to priority sectors. Government of India nationalized the banks to make them as an

instrument of economic and social change and the mandate given to the banks was to expand

their networks in rural areas and to give loans to priority sectors such as small scale industries,

self-employed groups, agriculture and schemes involving women.

To a certain extent the banking sector has achieved this mandate. Lead Bank Scheme enabled the

banking system to expand its network in a planned way and make available banking series to the

large number of population and touch every strata of society by extending credit to their

productive endeavours. This is evident from the fact that population per office of commercial

bank has come down from 66,000 in the year 1969 to 11,000 in 2004. Similarly, share of

advances of public sector banks to priority sector increased form 14.6% in 1969 to 44% of the

net bank credit. The number of deposit accounts of the banking system increased from over 3

crores in 1969 to over 30 crores. Borrowed accounts increased from 2.50 lakhs to over 2.68

crores.

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1.2 Abstract

The Indian banking system has undergone significant transformation following financial sector

reforms. It is adopting international best practices with a vision to strengthen the banking sector.

Several prudential and provisioning norms have been introduced, and these are pressurizing

banks to improve efficiency and trim down NPAs to improve the financial health in the banking

system. In the background of these developments, this study strives to examine the state of affair

of the Non performing Assets (NPAs) of the public sector banks and private sector banks in India

with special reference to weaker sections. The study is based on the secondary data retrieved

from Report on Trend and Progress of Banking in India. The scope of the study is limited to the

analysis of NPAs of the public sector banks and private sector banks NPAs pertaining to only

weaker sections for the period seven (7) years i.e. from 2004-2010. It examines trend of NPAs

in weaker sections in both public sector and private sector banks .The data has been analyzed by

statistical tools suchas percentages and Compound Annual Growth Rate (CAGR). The study

observed that the public sector banks have achieveda greater penetration compared to the private

sector banks vis-à-vis the weaker sections.

1.3

In present times, banking in India is fairly mature in terms of supply, product range and reach.

But reach in rural India still remains a challenge for the public sector and private sector banks.

The Reserve Bank of India is mainly concerned with providing finance to weaker section of

society, development of priority sectors and providing credit under differential rate of interest

scheme. After reforms in 1991, the entry of many private players has been permitted. Post

liberalization demand PSB’s to compete with well diversified and resource rich private banks

and to provide fine funded services and unique products to suit customers need. PSB’s have

already sacrificed alot of their profits for achievement of social objectives. Due to cut throat

competition and technology, the PSB’s are thinking to improve productivity and profitability

which is essential to survive in a globalised economy. The future of PSB’s would be based on

their capability to continuously build good quality assets in an increasingly competitive

environment and maintaining capital adequacy and stringent prudential norms.

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1.4 CLASSIFICATION OF NPA’s:

As per the RBI guidelines any loan repayment which is delayed beyond 180 days has to be

identified as NPAs. NPAs are further classified into

i. Substandard Assets I.e. those which are NPA for a period not exceeding two years

(Up to 2 years).

ii. Doubtful Assets I.e. Loans which have remained NPA for a period exceeding two

years and which are not considered as loss assets. NPA accounts belonging to this

category are further classified as D1 – When the account remains NPA for 3rd year.

D2 – When the account remains NPA for 4th and 5th year. D3 – When the account

remains NPA for 6th year onwards.

iii. Loss Assets A loss asset is one where loss has been identified but the amount has not

been written off wholly or partly. In other words, such assets are considered as

uncollectible. As per RBI guidelines provisions for NPA are to be made as under:-

a) 10% of sub-standard assets

b) 20% for doubtful assets

c) 100% for loss assets.

As per recent guidelines even on standard assets a provision @ 0.25% is required to be made. In

this connection following quotation from Narasimham Committee Report 1998 is worth quoting

“NPAs in 1992 were uncomfortably high for most of our PSBs and for some, high enough to

warrant concern, especially where the ratio of NPAs to Capital funds was disturbing high and in

some cases exceed net worth and undermined solvency. If the depositor’s money in such cases

was not at risk, as it strictly would otherwise have been, it is because of the implicitly guarantee

provided by the state ownership of the banks. Since 1992, there has been some improvement

even with a progressive tightening of the definition in the level of NPAs of the public sector

banks as a group. In spite of some write-off of loss accounts in this period, gross NPAs, which

perhaps reflects the true extent of contamination of the portfolios, were as high as 23.2% of the

total advances in March 1993 but have since come down from 14.5% in March 1994 to around

Rs.20, 000 Crores or 9.2% in March, 1997” To find out the causes of NPAs in Indian banking

sector, the total NPAs are to be classified into two broad categories viz:

i. Legacy NPAs

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ii. New NPAs

i. Legacy NPAs These are the NPAs acquired even before the prudential accounting norms were

introduced. Government has given the task of social banking to the PSBs and issued guidelines

and framed policies whereby 40% of the total advances must go to priority sector. Here only the

quantity of advances is emphasized ignoring the quality of lending. The Narasimham committee

report assets “Directed Credit has proportionately higher share in NPA portfolio of banks and has

been one of the factors responsible for erosion in the quality of banks assets”. In this connection

Narasimham Committee Report 1998 quotes “the causes of high proportion of NPAs are varied.

Poor credit decision by bank management, difficult recovery environment and changes both

cyclical and structural in the larger economic environment represent some of the micro and

macro aspects of this. This is not all. Often, as international experience has shown, a high

incidence of NPAs could be traced by policies of direct credit, not to speak of crude form of

behest lending. There is no inherent mistake in setting out social priorities for bank lending.

Social banking need not conflict with canons of sound banking but when banks are required by

directive to meet specific quantitative targets, there is, as our experience has shown, the danger

of erosion of the quality of loan portfolio.”

ii. New NPAs.

A critical analysis of NPAs in various banks reveals that in addition to priority sector, advances

to large industries also forms part of NPAs. The share of small advances of rural sector is very

small compared to the large advances. NPAs in percentage terms in some of the priority sector

advances may be higher but quantum wise, its contribution to total NPAs is not very significant.

Whereas percentage of NPAs in case of large advances may be lower but it forms the major

chunk of the total NPAs. Priority sector advances, as a percentage of NPAs may be higher, but

quantity-wise, are not a high figure. Large advances, as a percentage of NPAs are lower, but

quantity-wise is a higher figure. b. Non-performing Asset (NPA) has emerged since over a

decade as an alarming threat to the banking industry in our country sending distressing signals on

the sustainability of the affected banks. The positive results of the chain of measures affected

under banking reforms by the Government of India and RBI in terms of the two Narasimham

Committee Reports in this contemporary period have been neutralized by the ill effects of this

surging threat. Despite various correctional steps administered to solve and end this problem,

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concrete results are eluding. It is a sweeping and all pervasive virus confronted universally on

banking and financial institutions. The severity of the problem is however actually suffered by

Public Sector banks, Private Sector Banks & Co-operative banks & NBFC.

1.5 Development and Comparisons of Banks and Non Banking Financial Institution:

Public banks brought about a structural change in the banking industry with the commitment of

the government to implement social control on banks to make them realise the national goal of

developing the economy. The major segment of banking sector came under the control of the

government. Social control measures were also implemented such as priority sector lending

targets. This led to the massive expansion as a banking industry to borrowers across the country.

These developments created a strong network of public Sector banks meant to bring about a

socio economic transformation in the society. The share of credit to agriculture which constituted

a small portion for a long time improved significantly with the onset of lead bank scheme and

district plan. Indian banking sector have come a long way when it competitive and complex in

nature. The Implementation of Basel II has had a positive impact on the capital profile of the

Public sector banks. In base l Uniform risk rate was equally attached to all advances irrespective

of degree of risk. In India number of Private banks increased and their financial operations also

increased considerably. Though the banking principles and rule and regulation followed were the

same between Public sector banks and private sector banks but the competition spirit in banking

sector increased to a greater extent with the result the advances and selection of borrowers varied

with the result the profitability and quality of the assets varied from public sector to the private

sector, Hence the study involved the comparison between the private sector and the public sector

banks. Private Banks charge high rate of interest and also issue large number of credit card to the

individual as compared to public sector banks. Cooperative banks are expected to support

economically backward section of the society especially in rural areas. The advance or finance

provided to the borrowers may be to start new business or for the purpose of agriculture or

farmers. There is a study increase in the quantity of advances but there should also be increase in

the quality of advances and recovery. The study has been conducted on Urban Scheduled bank

situated. Since the number of cooperative bank is large in number and they have been classified

as Scheduled Urban Cooperative Bank, State cooperative banks, District Cooperative Bank,

Rural Cooperative banks, Local Cooperative Banks. Hence the research study has been

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compared to Public banks, Private Banks along with Cooperative banks. The Reserve Bank of

India is more stringent in framing banking rules and regulations. Inspite of the strict banking

laws the cooperative banks are able to meet the required formalities. The comparison is required

to find out the scope of improvement in scheduled Urban Cooperative banks so as to be as

competitive as Public Sector banks and Private sector banks Today schedule Urban Cooperative

banks are expected to support all sections of borrowers by financing them to start a new business

or for agricultural purpose the banks accepts deposits from the members and lend money to

needy persons. Since their main objective is to support priority sector, farmer, agriculturist, SSI,

artisans, small traders and salary earners. Recovery becomes difficult and leads to NPA.

Generally cooperative banks do not issue credit cards but they issue Kissan card which is may

prove to be doubtful debts. Non Banking Finance Company is not a regular bank but they raise

the capital through public issues. Hence Reserve Bank of India is very stringent in passing rules

and regulations. The Non Banking Financial Institution is more careful in lending loans. They

prefer only collateral security and also and along with collateral security they also insist on

Guarantors. The research study involves those Non Banking Finance who provides general loans

.Some Non Banking Finance lend specific kind of loan which may not be appropriate to the

research study. The comparison enabled to bring about striking features of success on recovery

proceedings and quality of the assets with reduction in NPA or not.

1.6 Non-Banking Financial Company

In consolidation of the banking sector, one has to focus on the nonbanking financial sector like

NBFCs and Unincorporated Bodies and thinks in terms of integrating them in financial system

along with the banks. In India, moneylenders, chits and other type of financial institutions play a

very large role in the credit markets for the unorganised sectors in trade, restaurants, transport,

construction, and service activities. It is to be noted that the market knowledge and information

regarding these activities like retail trade are not fully available with the commercial banker on

updated basis. By and large public sector banks have been geared to ‘Asset Based Lending’

rather lending based on the forecast cash flows. Activities like trade, transport, hotels and

restaurants, constructions etc, there are significant fluctuations in cash flows on a daily basis. In

other words risk assessment capabilities are not adequate in the context of these activities. Also

funds need to be available to these players without much paper work and based on personal

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assessment. Hence, the NBFC mostly finances these activities in consolidation of banking sector

should focus on integrating credit markets which comprises of banking and non banking sector.

Any consolidation should evaluate the following:

Reduction in interest cost, and hence benefits the ultimate consumer;

Enhancing the credit delivery mechanisms;

Introduction of rating processes at retail level

Creating a level playing field when global players enter the Indian markets;

Reversing the inverse relationship between the size of borrowing and the cost of borrowing.

Hence it is necessary for the Indian financial market to bring about the restructuring of the

banking sector by comparing or merging banking sector and non banking sector ensure the

growth of the economy along with the adequate availability of the credit to the fast growing

sectors of the economy.

1.7 Co operative Banking Sector

In a competitive environment, the size of the organisation is going to matter very much as it

provides a lot of advantage to the organisation. The size helps the banks in terms of cost

advantage, technological advancement, competitive pricing, better resistance against market

attacks, portfolio expansion and so on. At times, sheer size helps one to face the tough

environment. Now the Indian banking has moved close to complete technology banking as it

provides many advantages. Starting from fund transfer to settlements, all are done through

technology banking. Cooperative banks cannot remain silent on this very important issue

Adoption of technology and asset management is not a choice but a compulsion for survival.

Some cooperative bank with a modern banking facilities, loan modules, etc which enables the

cooperative banks to earn desired profits. Consolidation will surely help cooperative banks in

this direction.

There are many operational concerns and problems cropping with the consolidation of banks.

The important one are with regard to the customers like interest rates of deposits, loans and

advances, asset quality(NPA levels) difference in the competency level of the employees of the

acquirer and acquired banks and so on. These issues need to be carefully listed out and analysed

in order to synchronise ll these operational issues and make things hassle free for the customers

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of both the banks, particularly the acquired bank. The cooperative banks should maintain high

capital adequacy ratio to meet the loss and also maintain capital to risk weighted assets ratio of

the acquired banks. The study has been compared to Public Banks, Private Banks, Co operative

banks and Non Banking Financial institutions on policies, appraisal stage, sanctioning stage and

disbursement stage and post disbursement stage. The comparison is also made on level of NPA

in these sectors and also importance is given to priority lending, non priority lending, SSI, and

agricultural lending.

1.8 Credit and Risk Framework of Indian Banks

Credit is the backbone of the banking structure. Diminishing growth rates for credit with rising

NPAs are not good news for the banking system in general. Measures need to be put in place to

arrest this downward slide, and the deceleration of lending is definitely not the answer.

The future of the banking system will depend largely on the risk management dynamics and the

management of credit risk is the most critical component of that framework. As Indian banks

move into the new high-powered world of financial operations and trading, there will be a

requirement for more sophisticated and consistent models of risk assessment – as well as post-

disbursement monitoring. Credit risk is about 70% of a bank’s total risk, the rest of the 30%

being shared between market risk and operational Risk. Not much can be done about market risk,

but operational risk and credit risk must be managed by banks.

As presented in a study done by Standard & Poor’s, mid-corporate and small and medium-sized

enterprise (SME) lending are the key areas of challenge for Indian Banks. The non-performing

loans of these segments range between 8 – 12% per annum.

There are several key reasons banks possess such a high rate of NPAs – which can be

outlined as follows:

Speculation – Investing in High Risk Assets

Default

Fraudulent practices

Diversion of funds

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Internal factors such as inefficient management, and inappropriate systems and technology

External factors

The question going forward really is: what can be done to address these issues?

Managing Risk: A Proactive Approach

Jasrin Singh, Director, Business Development, South Asia Omega Performance The following

list of measures is a suggested intervention program to bring about change that ensures that

Indian banks create healthy and sustainable loan portfolios:

A stable and standard international credit assessment framework

Indian banks would need to adopt a standard, international credit assessment framework which is

designed to take into account all elements of credit risk, including: business risk, operational

risk, industry risk and market risk. Despite each country market’s unique needs, the banking

sector’s credit risk assessment must be of a global standard.

The DNA of the bank: preventive measures or curative measures

The two dimensions of managing risk are preventive measures and curative measures.

Preventive measures include pre-disbursement policies, risk assessment, risk measurement, and

risk-based pricing. These are worth much more in their weight than any curative measures,

which are a reactionary form of risk management. The preventive measures and credit

assessment framework should become part of the bank’s DNA and the curative measures should

be utilised only in unforeseen circumstances

Post-disbursement loan monitoring

Credit risk is not entirely addressed at the time a loan is disbursed. While preventive measures

will have a great impact on improving loan quality, early detection and management of problem

loans is fundamental to ensuring a high quality, sustainable credit portfolio. Appropriate tools for

post-disbursement loan monitoring must become an essential part of the credit risk assessment

framework.

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Training of credit and sales personnel

Training is required to help bank employees understand and implement an objective credit risk

assessment framework. To encourage transformation, organisations will need to invest in

training. First, bank employees are required to understand core credit principles, bank growth

objectives, and customers business goals and challenges. Second, staff must be able to apply this

knowledge effectively to better serve customers, armed with specific techniques required to drive

profitable business opportunities. Third, staff must be able to differentiate themselves and their

bank from the competition. This can be achieved through the deployment of proven-effective

training solutions and a thorough training culture.

Alignment of interests between credit and sales staff

It is as important that front-line staff such as salespeople, relationship managers, and branch

managers are well-versed with the credit decisioning process as their underwriting and credit

management colleagues. Sales team revenue-and-reward models should account for portfolio

quality, not purely sales volume.

If Indian Banks were to consider looking at all these five measures, the future probability of an

expanding NPA volume is likely to be reduced.

1.9 Role of CRA in credit risk assessment and its impact in terms of information value

Information value of credit ratings:

In the last couple of years, as NPA levels and SAs have grown considerably in the economy, a

significant proportion is skewed towards corporates. Consequently, credit risk assessment, credit

administration and monitoring has come increasingly into focus. The suitability of current credit

risk assessment has often come into question. Credit rating agencies across the world are

increasingly becoming an important component in the value chain of credit risk assessment.

Credit rating is an indicator to measure the creditworthiness of borrowers and acts as an

intermediary between the issuer (borrower) and investor (banks) to minimise information

asymmetries about the riskiness of investment products on offer. In general, credit rating

provides a third party with independent information on default risk i.e. the likelihood of default

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of an issuer on a debt instrument, relative to the respective likelihoods of default of other issuers

and therefore becomes a useful ready-to-use tool for assessing credit risk. In the case of

sanctioning loans, banks use ratings as a filter and sometimes perform an additional check

through an independent due diligence review or credit matrix. So, banks may use the credit

rating issued by CRAs to the debtor as important information during the credit appraisal. The

RBI’s regulatory framework requires banks to have their own credit risk assessment framework

for lending and investment decisions and not rely only on ratings assigned by credit rating

agencies. The Indian banking system’s mandated reliance on external credit ratings is limited to

capital adequacy computation for credit risk and general market risk under standardised approach

of Basel II. As banks develop their internal ratings model as mandated by the Advanced Basel

framework, they can validate the credit rating for a particular borrower generated from that

model with that of the publicly available ratings by CRAs. Banks can also seek information from

CRAs if there is wide variation in its credit assessment vis-a-vis the rating agencies. Banks and

CRAs should be able to contribute to developing an ecosystem where credit assessments become

more effective. Current RBI regulations stipulate that if a bank has decided to use the ratings of

chosen credit rating agencies for a given type of claim (loans), it can use only the ratings of the

same credit rating agencies (for subsequent reviews), despite the fact that some of these claims

may be rated by other chosen credit rating agencies whose ratings the bank has decided not to

use. In respect of exposures and obligors having multiple ratings from chosen credit rating

agencies, for risk weight calculation, banks will use higher risk weight if there are two ratings

accorded by chosen credit rating agencies that map into different risk weights. Similarly, if there

are three or more ratings accorded by chosen credit rating agencies with different risk weights,

the ratings corresponding to the two lowest risk weights should be referred to and the higher of

those two risk weights should be applied. RBI guidelines also stipulate that as a general rule,

banks need to use only solicited ratings from chosen credit rating agencies and cannot consider

any ratings given on an unsolicited basis by CRAs for risk weight calculation as per the

standardised approach. While external credit rating for corporate loans is not compulsory under

Basel II, banks have to assign 100% for unrated corporate claims (both long- and short-term)

which was relaxed from 150 to 100% during the 2008 financial crisis. The regulation has brought

many smaller firms within the fold of credit rating. In this paper, we have only considered

exposures of banks for corporate loans greater than 5 crore INR as any loan upto 5 crore INR is

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considered as retail exposure. Borrowers can benefit from the rating exercise as this can help

them tone up their management systems and business models. Banks also provide loans as social

obligation to institutions with a weak balance sheet like such as state electricity boards, etc. The

credit risk on the balance sheet of the lending banks and institutions could be far higher than

what is declared, considering the weak financials of those companies. CRAs could play a vital

role in assessing these risks.

2.0 Business models of credit rating agencies and their impact

It is imperative that the business model of the CRAs need to ensure that credit ratings are of high

quality, accurately measure creditworthiness and should be the product of a strong and

independent process. A possible inaccuracy in ratings can pose a threat to financial stability by

underestimating the riskiness of investments of regulated entities. In case of a bank loan rating of

a borrower, the problem of underestimation of risk can lead to inaccurate capital calculation due

to inflated ratings and could pose a significant threat to the financial stability of individual

financial institutions as well as the whole financial system. Conversely, ratings that

overestimated risk will impose excessive capital requirement on banks, increasing costs to the

economy as a whole and reducing shareholder returns.

Functions of CRAs and associated business models:

Post the sub-prime crisis in 2008, the CRAs have come under fire for their inability to detect the

flaws in the system and also conflict of interest in their business models. In India, most of the

credit rating agencies have rating and non-rating businesses. CRAs in India rate a large number

of financial products including the following:

1. Bonds and debentures

2. Commercial paper

3. Structured finance products

4. Bank loans

5. Fixed deposits and bank certificate of deposits

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6. Mutual fund debt schemes

7. Initial public offers (IPOs)

CRAs also undertake customised credit research of a number of borrowers in a credit portfolio,

for the use of the lender. Their to understand the business and operations coupled with the

expertise of building frameworks for relative evaluation puts them in good stead.

Feasibility of an umbrella regulator model

The multiplicity of regulators has necessitated the need for interregulatory co-ordination. It has

become necessary for policy makers to look at the fact that there are apprehensions about

regulatory arbitrage taking advantage of lack of co-ordination among various regulators. Policy

makers need to identify areas where they could facilitate an optimal environment for removal of

asymmetric information. It relates to the design, structure and extent of the regulatory structure

pertaining to the operations of CRAs, and an enquiry as to whether the prevailing policy

regulatory regime has helped or harmed their functioning. While SEBI currently regulates credit

rating, such ratings are much more used by other regulators where rating advisory is often a part

of the regulations. SEBI’s jurisdiction over the CRAs only covers securities as defined under the

Securities Contract (Regulation) Act, 1956 and does not cover the activities governed by other

regulators. Existing SEBI regulations may not be adequate to cover the issues and concerns put

forth by other regulators. The SEBI report further suggests the need for a lead regulator. In the

awake of increasing NPAs in the system, it needs an overhaul. The feasibility of forming an

umbrella regulator with representations from respective regulators, SEBI, RBI, IRDA, PFRDA

and others can be looked into. While independent regulators can frame their guidelines

applicable to sectors they regulate, a holistic regulatory framework needs to be developed

considering inputs from all participants. Currently, a standing committee for CRAs has been

constituted which comprises of representations from regulatory bodies of the securities market

(SEBI), banking sector (RBI), insurance sector (IRDA) and pension funds (PFRDA). The

committee has met at several occasions to deliberate on various regulatory issues.

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Regulatory role for improving efficacy of CRAs

Globally, the need for strong regulations governing CRAs has come into focus post the 2008

subprime crisis. Subsequently, significant regulatory changes have been observed in the

developed economies (OECD). In USA, the Credit Rating Agency Reform Act and Dodd-Frank

Wall Street Reform and Consumer Protection Act have enhanced the Security Exchange

Commission’s (SEC) power to regulate Nationally Recognised Statistical Rating Organisations’

(NRSROs) by adopting several rules. The areas covered under the rules include record-keeping,

conflict of interest with respect to sales and marketing practices, disclosures of data and

assumptions underlying credit ratings, statistics, annual reports on internal controls and

consistent application of ratings symbols. However, the law prohibits the SEC from regulating an

NRSRO’s rating methodologies. Banks having inter-state licences are generally required to make

assessments of a security’s creditworthiness to determine its ‘investment grade.’ and remove

references to external credit ratings. The Federal Deposit Insurance Corporation (FDIC) ensures

depository institutions using IRB (Internal Ratings Based) supplement the use of CRAs with

internal due diligence processes and additional analyses to demonstrate that CRAs are used only

in an auxiliary role in the calculation of final rating values. For the ‘Standardised Approach’,

banks use alternatives to CRA as well as alternative standards for assessing whether securities

are of investment grade or not. In Australia, major banks use (IRB) approaches to assess credit

risk and are required to form their own views on creditworthiness of the borrowers even though

external ratings may constitute an input in that view as opposed to relying solely on CRA ratings.

The banks are also subjected to continuous monitoring and review mechanism by the Australian

Prudential Regulation Authority (APRA). While other authorised deposit taking institutions

(ADIs) use a more simplistic approach, they are also required to supplement CRA ratings when

determining the credit risk exposures. The EU has also formulated regulations on CRAs (CRA

Regulation III) to reduce reliance on external ratings. The Capital Requirements Directive (CRR)

require credit institutions to have strong credit evaluation framework and credit decision

processes in place irrespective of whether they grant loans or incur securitisation exposures.

However, for calculation of regulatory bank capital requirements, rating agency assessments may

be, in certain cases applied as a basis for differentiating capital requirements according to risks,

and not for determining the minimum required quantum of capital itself. The CRD framework as

a whole provides banks with an incentive to use internal rather than external credit ratings even

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for calculating regulatory capital requirements. In India, the question of improving the efficacy

of CRAs needs to be looked from a holistic perspective where all participants in the ecosystem;

the regulators, CRAs, corporates and investors (banks) needs to work jointly towards a better

system of credit risk assessment and monitoring. From a regulatory perspective it is important

that apart from putting up a strong regulatory framework, they also upgrade their skills for

greater due diligence to evaluate effectively the ratings that are given by CRAs. The banks need

to move towards risk based pricing whereby they can use rating as more than just a mandatory

exercise by identifying greater incentives for them to adopt ratings. It has been observed that

globally, self-regulation for CRAs has not worked effectively due to revenue and profitability

pressures and loss of market share. Also, the fact that there remains conflict of interest from the

Issuer Pay Model and the entire gamut of non-rating services provided by the CRAs need to be

evaluated.

In the last couple of years, as Indian economy witnessed downturn trends, the banks have been

straddled with high NPAs and restructured assets. Macro-economic dynamics may be a major

contributor, however we also believe that inadequate credit assessments and monitoring during

the upturn in the economy has also contributed to the same. All participants in the ecosystem, the

banks, regulators, borrowers and CRAs need to take responsibility. Our view is while we cannot

undo the mistakes or errors that have been committed in terms of credit assessment and

monitoring, effective steps needs to be taken and a holistic approach is the best way forward. All

stakeholders in the ecosystem need to proactively contribute towards a better credit assessment

and monitoring framework with the regulator enabling such initiatives. Some of our major

recommendations include the following:

• Effective use of early warning systems as the monitoring mechanism by the banks to

proactively detect and resolve issues related to the credit risk of the borrower. For the resolution

of NPAs, an end to end NPA lifecycle management can also help.

• To create a holistic regulatory framework for credit ratings along with an umbrella regulator.

• To minimise the opportunity of regulatory arbitrage.

• Efficacy of CRAs being monitored by the regulator through adoption of remedial measures for

resolving conflict of interest of CRAs.

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• Encouraging CRAs to develop industry specific expertise.

• Banks moving towards true risk based pricing thus encouraging borrowers to get themselves

rated (solicited ratings). Currently banks also monitor market risks, however it is imperative that

banks use this information also in conjunction with credit assessment to have a true evaluation of

the borrower.

• Banks should also be encouraged to develop their internal rating models and validate these

ratings by comparing them with publicly available ratings and also seek more information from

the rating agencies, if necessary to be doubly sure of their credit assessment process.

• Feasibility of creation of a centralised platform for credit ratings, where issuers can approach to

get themselves rated and allocation of the work can be done to CRAs based on industry expertise

and their previous experience amongst others. This will also reduce the conflict of interest and

can prevent rating shopping by borrowers.

• CRAs also need to effectively use market information in their credit ratings methodology and

put in place a strong corporate governance so that conflict of interest can be effectively resolved.

The Financial Stability Board (FSB) which includes members from G20, had set up the

Implementation Group on Credit Rating Agencies (CRAs) to assess the position of compliance

of regulatory framework in the country vis-à-vis the FSB principles for reducing reliance on

CRA ratings. The FSB in its progress report to the St Petersburg G20 Summit titled Credit

Rating Agencies: Reducing reliance and strengthening oversight, states that “The Principles

recognise that CRAs play an important role and their ratings can appropriately be used as an

input to firms’ own judgment as part of internal credit assessment processes. But any use of CRA

ratings by a firm should not be mechanistic and does not lessen its own responsibility to ensure

that its credit exposures are based on sound assessments”. The FSB, in its recently published

peer review report on national authorities’ implementation of the FSB Principles for Reducing

Reliance on CRA Ratings finds that Indian regulatory regime has put in place systems and

procedures to develop internal credit risk assessment and due diligence by the market

participants. We also strongly believe with the participation and contribution of all stakeholders,

a holistic credit assessment and monitoring is the way forward to rein in the high level of NPAs

and restructured assets.

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India is seeing a regulatory upheaval in the way the Government is addressing the NPA “crisis”.

The efforts are visible, but the results may be achieved only on a medium- to longterm basis.

According to the survey respondents, stricter penal measures for fraudulent borrowers, e.g.,

restricting access to additional bank borrowing and restructuring, prompt reporting of cases to

law enforcement agencies etc., would act as deterrents and help prevent larger exposures of bad

accounts in the banks’ books. Widening of the scope of “wilful defaulter” ably supported by

Securities and Exchange Board of India (SEBI) would assist in restricting defaulting borrowers

from accessing the equity and debt markets. The creation of the Central Fraud Registry would

benefit banks in obtaining access to critical details of frauds reported by other banks and thereby

avoid lending to tainted borrowers. The boards of the banks will conduct a detailed scrutiny of

the quarterly and annual fi.nancial results, review NPA management and reported NPA and

provisioning integrity. The new RBI circular on “Framework for dealing with loan frauds”

demonstrates its commitment to addressing concerns pertaining to detection, reporting,

mitigating and accountability with regards to loan frauds. Significant expansion in the role of

“Fraud Monitoring Group” (FMG) within the banks is expected based on the circular. Further,

importance has also been laid on implementing a strong whistle-blower policy to encourage

employees to report concerns. Also, the recent circular around “Strategic Debt Restructuring

Scheme” is a firm step by RBI giving strong clutches to the bankers to take-over management

control of the defaulters. This would be where they feel the incapability of the borrower

company to come out of stress due to operational/ managerial inefficiencies

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Addressing NPA problem of Indian Banks:

Root of the NPA problem in Indian Banks is post 2009 – when World was doing QE to stave off

2008 recession and India was not in any kind of need for a QE (since GDP growth had lowered

down but there was no recession in India) – Congress still did QE in India on pretence of World

doing QE – and gave massive loans to crony businessmen close to Congress – just see the list of

who’s who – Mallya, Jindals, Jaypee, Ruias of Essar etc – when global Trade had tanked, where

would this money go, to create capacities for which there was no end demand, or to be siphoned

off by these Crony capitalists.

With giving a free hand to Raghuram Rajan (R3) – who told Banks – do whatever it takes to

recover this money – and first of all, recognize all such bad loans. Result – Debt for Equity

swaps, selling of assets, Wilful Defaulter tag, Name & Shame defaulters and recognition of

NPA’s with concurrent huge losses of Banks.

Clearly, nationalization of Banks by Indira Gandhi was a colossal mistake. PSU Banks are prone

to arm twisting by Ministers, their Management is for short-term and hence is disinterested in

long-term health of the Bank, most often Chairman position of PSU Banks is bought by corrupt

Bankers and hence their foremost interest is to earn while on the job, our Judicial system being

stuck in backlog of cases and prone to misuse – even good Acts like Sarfaesi & DRT’s are not

working. The new Bankruptcy Act is a welcome step and amendments to Sarfaesi & DRT Acts

in next session of Parliament will aid recoveries.

Crux of the problem also lies in the fact that Project Funding as the term goes is not feasible in

India, due to Judiciary being in permanent Coma. Project Funding abroad means Banks take

project risk (Primary Collateral being Charge on cash flows and Charge on fixed & variable

assets being created). But in India, since project risk is traditionally sky high (because Judiciary

is unreliable), Banks interpret Project Funding to mean inclusion of Personal Guarantees,

Corporate Guarantees, Charge on personal assets of Promoters etc.

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NPA problem of Indian Banks

While this is understandable, but look at history of Banks trying to enforce such Guarantees and

charge on assets to recover bad loans – Loopholes in Judicial process and delays are exploited to

the hilt by Promoters who have loads of money siphoned off from the Loans to their company!

Reality is – Promoter overstates value of assets to create a bigger project – so that when Loan

comes in, he siphons off this loan and re-routes this as equity. In reality – Promoters takes off his

initial equity completely and the entire project is, in fact, funded by Bank loan. This is the dark

truth! When project goes bad, what can Bank do? Sell off those assets or try to run the company?

Both prove a failure. And NPA’s result.

Resolution to the problem – as currently happening – recognize all such bad loans to get the

extent of the problem. Get Bankruptcy Act, amendments to Sarfaesi & DRT Acts in place (which

will happen soon), then since de-nationalization of PSU Banks is not possible (lack of BJP

majority in Rajya Sabha), first merge Banks to reduce their number from 27 to a decent 6. Then

offload stakes in these 6 big Banks by keeping Government stake at 51%. Simultaneously, force

Promoters to offload their assets and pay back the Banks.

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About 12 percent of Indian banks' assets are currently stressed. What this means is that for every

Rs 100 they have lent, chances of getting Rs 12 back are less. The more worrying fact is that

over 90 percent of this stress is on the books of the country’s state-run banks. These lenders,

traditionally, have weaker autonomy in lending operations, tendency to engage in reckless

lending and are more vulnerable to the corporate-political nexus.

There is no magic wand to make NPAs disappear. It is not easy, said a senior banker, who was

present at the meeting. “It all depends upon how fast the economy comes back on track, stressed

assets revive and companies start paying back. Till then, the only option for banks is to avoid

further lending,” said the official. That doesn’t augur well for an economy, which desperately

needs funds to kick off the growth-phase.

The slowdown in credit growth is already visible.

There has been no major corporate lending in the past 2-3 years and most banks have shifted

their focus to the safer retail lending to grow their books. Indian banks’ loan growth to industries

shrank 1.1 percent in the first six months of this fiscal compared with a negative growth of 0.4

percent in the corresponding period of last year.

The problem

In some cases, like United Bank of India and Chennai-based Indian Overseas Bank (IOB), the

level of gross NPAs has zoomed to painful proportions. IOB’s stressed loans escalated to 11

percent in the September quarter from 9.4 percent in the preceding quarter. In the case of United

Bank, the RBI had to even impose a temporary lending ban on account of high NPAs.

Even bigger banks like Bank of Baroda saw a sharp jump in GNPAs to 5.56 percent from 4.13

percent in the first quarter. The only major exception to this trend is State Bank of India (SBI).

The tangible part of the bad loan pain on the government banks and, in turn, on their owner (the

government) is the immense capital burden.

The estimated (moving) capital requirement of India's state-run banks to meet the Basel-III

norms over the next five years is about Rs 2,40,000 crore. Incidentally, that’s only a tad less than

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the GNPAs of India's 40-listed banks (Rs 300,000 crore), most of which are on state-run lenders'

balance sheets.

After much persuasion from the RBI, Jaitley later agreed to increase the capital infusion to Rs

70,000 crore. But, experts say even that is too little.

“The government is now batting like Sehwag without seeing the ball,” said Abhishek Kothari,

equity research analyst at Anand Rathi Securities. “On the one hand, they need PSBs to clean up

their balance sheets, on the other aid growth through increased lending. A steroid injection so

late won’t help in quick healing,” Kothari said.

The bad loan scenario of Indian banks hasn’t improved significantly in the recent years on

account of three factors. One, the revival in the investment cycle hasn’t taken strong hold yet.

And the second, the process of rebooting of the delayed projects hasn’t yet translated into

improved cash flows for companies.

Does the Modi government have the wherewithal to fulfil its commitment towards India's state-

run banks? Experts are doubtful on account of its fiscal constraints.

State-run banks’ capital requirement appears to be well beyond the capacity of the government

coffers, especially when the fiscal situation doesn’t look healthy with higher cash out go if the

7th Pay Commission proposals on compensation to public sector staff and pensioners are

accepted. Especially since revenue from corporate tax collection is likely to decline. The

government’s ability to raise funds from divestment is critical.

How did the NPAs pile up?

It didn’t happen overnight.

Besides the overall economic slowdown, one major reason why the NPAs shot up is the reckless

lending resorted by state-run banks, between 2008-09 to 2011-12, without adequately assessing

the risks. The focus was on volume growth and not quality, said the banker quoted earlier.

“It was high competition that was driving the credit operations and not prudence. The idea by

every bank chairman appeared to grow the loan book as quickly as possible by sanctioning large

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ticket loans and not the quality of assets. The hope was an economic boom, thereafter, which

never happened,” the banker said.

Adding as many zeroes in their total business numbers and advertising it on the mastheads of

national newspapers have become an annual ritual for India's public sector banks, more of an

exercise aimed at appeasing the political bosses and ensuring a post-retirement berth, rather than

giving a true account of business to the shareholders.

Secondly, interested party lending and the role of middlemen played a key role. The banker-

middleman-corporate nexus operated in full swing. Most often than not, these interested parties

are those linked to influential politicians and business groups.

There have been several occasions, which bankers typically fear to say in the open, when they

have received informal missives from ministers to lend to a particular company, wherein that

minister has some interest. Middle-level bank officials at state-run banks often succumbed to

such pressures

Third, a new set of promoters, who wouldn’t pay back loans to banks despite having the ability

to do so emerged more often. The RBI called them wilful defaulters. Once a company or

promoters is tagged as wilful defaulter, no other financial institution will lend to such parties, nor

can these promoters be part of any other organizations.

The latest such case is liquor baron, Vijay Mallya, whose grounded airline, Kingfisher, owes

over Rs 7,000 crore to some 17 banks. Recently, SBI classified Kingfisher and its guarantors as

wilful defaulters after a prolonged legal battle. Other banks too are likely to follow the suit.

As per the data obtained from the All India Bank Employees Association, there are 7,035 cases

of wilful defaults with a bad loan pile to the tune of Rs 58,792 crores as on 31 March, 2015.

Fourth, bad loan picture turned grim after banks started pushing loans to the restructured

category to prevent them becoming NPAs. This only postponed the problem and started to

backfire. Many of these loans were close to NPAs when they were admitted to recasts.

This practice, however, came to an end when the RBI withdrew special regulatory dispensation

for rejigged loans, forcing banks to treat newly restructured loans on par with bad loans.

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The chunk of fresh NPAs emerging from restructured loans have been on the rise since many

such accounts failed to revive. Banks did this cover-up largely in the infrastructure sector. On a

conservative basis, about Rs 6 lakh crore loans are currently being restructured both under the

CDR channel and on a bilateral basis.

Under the RBI norms, for every loan that turns bad (when dues remain unpaid for 90 days or

more), banks have to set aside money in the form of provisions. This ranges from 20 percent to

100 percent of the loan value, depending on how bad the state of the underlying asset is.

That means if a Rs 100 loan goes bad to the loss category, the bank needs to set aside Rs 100

from its kitty to cover that loss. If the loan is restructured, the provision is 5 percent of the total

value. Such high provisions make additional capital a must for banks.

The solution

A slew of corrective measures initiated by the Modi government such as cleaning up the power

discom mess with state-supported revival package, increasing the tenure of bank chiefs and

creation of a bankruptcy code can aid the reduction in bad loans over a period of time.

But, the actual implementation of these promises is critical, says analysts.

“Measures such as bankruptcy law and strict action on wilful defaulters may aid in lowering

NPAs,” said Kothari of Anand Rathi Securities. “But, despite the promise of doing necessary

steps in power and other stressed sectors, nothing has happened in the one and a half years,”

Kothari said.

Speedy judicial resolution of cases involving large-ticket bad loans is critical for banks to

recover their dues. Many a times, after long years of litigation, the sharp erosion in the value of

underlying asset leaves nothing much for the lender to recover.

It is also crucial for the Modi government to give a serious thought to privatisation of

government banks. So far, this government has shown an aversion to the privatisation of banks.

It should learn from the experience of the private sector banks and show the guts to moot radical

reforms in the banking sector by privatising state-run banks. Arguably, the two-stage

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nationalisation of state-run banks has clearly failed to achieve the desired impact and its time for

the government to exit the business of banking and focus on governance.

It doesn’t make sense for the government to run banks for the simple reason that it doesn’t have

the fiscal ability to continue feeding the capital-starved lenders, especially in the backdrop of

high stress on their balance sheets.

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DIFFICULTIES WITH THE NON-PERFORMING ASSETS AND REVIEW OF

LITERATURE AND GENISIS OF COMMITTEES.

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2. DIFFICULTIES WITH THE NON-PERFORMING ASSETS:

1. Owners do not receive a market return on their capital. In the worst case, if the bank fails,

owners lose their assets. In modern times, this may affect a broad pool of shareholders.

2. Depositors do not receive a market return on savings. In the worst case if the bank fails,

depositors lose their assets or uninsured balance. Banks also redistribute losses to other

borrowers by charging higher interest rates. Lower deposit rates and higher lending rates repress

savings and financial markets, which hampers economic growth.

3. Non performing loans epitomize bad investment. They misallocate credit from good projects,

which do not receive funding, to failed projects. Bad investment ends up in misallocation of

capital and, by extension, labour and natural resources. The economy performs below its

productionpotential.

4. Non performing loans may spill over the banking system and contract the money stock, which

may lead to economic contraction. This spillover effect can channelize through illiquidity or

bank insolvency; (a) when many borrowers fail to pay interest, banks may experience liquidity

shortages. These shortages can jam payments across the country, (b) illiquidity constraints bank

in paying depositors e.g. cashing their paychecks. Banking panic follows. A run on banks by

depositors as part of the national money stock become inoperative. The money stock contracts

and economic contraction follows (c) undercapitalized banks exceeds the banks capital base.

Lending by banks has been highly politicized. It is common knowledge that loans are given to

various industrial houses not on commercial considerations and viability of project but on

political considerations; some politician would ask the bank to extend the loan to a particular

corporate and the bank would oblige. In normal circumstances banks, before extending any loan,

would make a thorough study of the actual need of the party concerned, the prospects of the

business in which it is engaged, its track record, the quality of management and so on. Since this

is not looked into, many of the loans become NPAs.

The loans for the weaker sections of the society and the waiving of the loans to farmers are

another dimension of the politicization of bank lending.

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Most of the depositor’s money has been frittered away by the banks at the instance of politicians,

while the same depositors are being made to pay through taxes to cover the losses of the bank.

2.2 REVIEW OF LITERATURE AND GENISIS OF COMMITTEES

RBI and Govt. of India had appointed various committees and Study Groups from time to time to

study in depth different aspects on Banks Credit, , Legal Reform and Non-Performing Assets.

All these subject matters are co-related and interconnected to this research study and hence it is

necessary to know, in brief, about the purpose of appointment of such Committees, their terms of

reference and some of the valuable recommendations made by them. Non- performing Assets

have been plaguing the Indian financial sector since long but were not in the public domain till

early nineties. By that time, significant amount of loan assets involving uncertainly with respect

to ultimate collection piled up creating concerns with the opinion makers about health of Indian

banking and financial sector. NPAs reflect natural waste of any economy. In advanced

economies the financial markets are well developed and segmented; with various players

operating in identified niches, catering to various users/risk segments. This constitutes an

effective institutional mechanism for targeting risks to players with appetite for such risks.

Commercial bank is conducted in a highly risk managed and mitigated ambience, unlike their

Indian counterparts who are often required to take unmitigated risk as a part of business policy.

2.3 VARIOUS COMMITTEE REPORTS – ON CREDIT

2.3.1 Thakkar Committee on Employment Potential (1970) The then Union Finance Minister

Shri Y.B. Chavan, while meeting the Chairman/ Custodians of the Public Sector Banks on 22nd

July 1970 indicated that the committee might be constituted to review the special credit schemes

of banks, with particular reference to their employment potential. The terms of reference were to

identify the types of selfemployed persons who should be considered for special financing.To

evolve guidelines in respect of security, rate of interest, period of repayments and other terms

and conditions.

2.3.2 Tandon Committee (1974) Till nationalization of the 14 major commercial banks in July

1969, the main contenders for banks credit were large and medium scale private industries and

internal and external trade. Nationalisation of the major commercial banks, called for a new

policy, both for deposit mobilization through accelerated branch expansion and for suitable

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disbursal of credit. Its terms of reference were to suggest guidelines for commercial banks to

follow up and supervise credit from the point of view of ensuring proper endures of funds and

keeps watch on the safety of the advances and to suggest the type of operational data and other

information that may be obtained by banks periodically from such borrowers by the Reserve

Bank of India from the lending banks. To make suggestions for prescribing inventory norms for

different industries both in the private and public sectors and indicate the broad criteria for

deviating from these norms.

2.3.3 Puri Committee on SSI (1975) Consequent to the discussions at the meeting of the

Standing Committee on credit facilities of the Small Scale Industry (SSI) Board and the

discussion that took place at the 33rd meeting of the Board in September, 1975, regarding credit

problems faced by small scale industries, the Government of India appointed High Powered

Committee under the Chairmanship of Shri I.C.Puri, the Development Commissioner (SSI), with

the following terms of reference: To examine the possibility of introducing a measure of

uniformity in the terms and conditions of finance and to suggest measures that should be taken

by small scale units to facilitate the flow of institutional finance.

2.3.4 N.K. Ambegaonkar Committee (1976) At the meeting of the regional consultative

committee for the North Eastern Region, held at Gauhati on 5th July, 1976, it was decided that

the RBI should appoint a small Working group to examine, inter-alia, the factors impending the

flow of bank credit in the Region and make recommendations for necessary changes in the

procedures and practices of banks so as to bring about rapid and all round banking development

in the region. The terms of reference were to identify the factors impeding the flow of bank

credit in the North Eastern Region. To recommend, in the context of the socio-economic features

of the region, suitable arrangements for expeditious disbursal of credit by commercial banks.

2.3.5 Raj Committee on lending to priority sector (1976-77) The nationalisation of the 14 major

scheduled commercial banks in July. brought in its wake a rapid growth in branch expansion,

particularly in the rural areas, accompanied by considerable rise in the deposits and advances.

RBI set up a Committee in June 1977 to study all aspects of the functioning of the Public Sector

of Banks under the Chairmanship of Shri James S. Raj. The terms of reference were to assess the

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impact of branch expansion that had taken place since 1969 and to examine whether any change

in the tempo and direction of such expansion is called for and to inquire into the present pattern

of branch expansion of public sector and to suggest the future course of action keeping in view

the need for rural development and removal of regional imbalances.

2.3.6. Chore Committee (1979) RBI appointed the Working Group to review the system of cash

credit in all its aspect under the Chairmanship of Mr. K.B. Chore, Additional Chief Officer,

Department of Banking Operations and Development, RBI. The terms of reference were to

review the operation of the cash credit system in recent years particularly with reference to the

gap between sanctioned credit limits and the extent of their utilization, to suggest modifications

in the system with a view to making the system more amenable to rational management of fund

by commercial banks.

2.3.7. Dr.K.S.Krishnaswamy Committee (1985) At the meeting of the Finance Minister with the

Chief Executive Officers of the Public Sector Banks held on 6th March, 1980.The terms of

reference to identify the specific groups which are to be assisted under the 20 Point Programme.

To identify the ways and means of rendering assistance to the beneficiaries. To look into the

question of fixing subtargets (within the enhanced overall target of 40% for assistance to priority

sectors) to the beneficiaries.

2.3.8 Dr. P.D. Ojha Committee (1988) Governor, RBI suggested to the Chief Executives of

Public Sector Banks at a meeting held on 17th October, 1987 that a field study would be carried

out with their personal participation in different districts all over the country and the findings

would be discussed in a Seminar. The terms of reference were to examine and recommend the

necessary procedures for effective co-ordination between the three institutional agencies viz.

Commercial Banks, Regional Rural Banks and Cooperative under the new area approach.

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2.4 VARIOUS COMMITTEE REPORTS ON NPA

1. Narsimhan Committee – Reform I (1991) The development of the financial sector is a major

achievement and it has contributed significantly to the increase in our savings rate, especially of

the household sector. The terms of reference were to examine the existing structure of the

financial system and its various components and to make recommendations for improving the

efficiency and effectiveness of the system with particular reference to the economy of operations,

accountability and profitability of the commercial banks and financial institutions.

2. Khan Committee on Financial Reforms (1997) RBI had constituted a 7 member Working

Group on 15th Dec. 1997 under the Chairmanship of Shri S.H. Khan, Chairman and Managing

Director of IDBI, keeping in view the need for evolving an efficient and competitive financial

system. The terms of reference were to review the Role, Structure and Operations of DFIs and

Commercial Banks in the emerging operating environment and suggest changes and to examine

whether DFIs could be given increased access to short term funds and the regulatory framework

needed for the purpose.

3. Tarapore Committee on Capital A/c Convertibility (1997) The Union Finance Minister,

Shri P. Chidambaram, in his Budget Speech for 1997-98 had indicated that the regulations

governing foreign exchange transactions need to be modernized and replaced by a new law

consistent with the objective of progressively liberalizing capital account transactions.

Committee on Capital Account Convertibility under the Chairmanship of Shri S.S. Tarapore was

appointed. The terms of reference were to review the international experience in relation to

Capital Account Convertibility and to indicate the preconditions for introduction of full Capital

Account Convertibility and to specify the consequences and time frame in which such measures

are to be taken.

4. Pannir Selvam Committee on NPA (1998) Banking Division constituted a 3 Member

Committee under the chairmanship of Shri A.T. Pannir Selvam, Chairman, IBA and Chairman &

Managing Director, Union Bank of India. The terms of reference assigned to the above

Committee were Causes of NPAs, factors for slump in recovery of loans; measures to be taken

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for effective recovery of bank dues and reduction of NPAs and banks wise study on factors

responsible for the NPAs and banks specific suggestions for recovery.

5. Narsimhan Committee – Reform II (1998): Reform of the Indian banking sector is now

under way following the recommendations of the Committee on Financial System (CFS), which

reported in 1991. The second generation of reform could be conveniently looked at in terms of 3

broad interrelated issues and actions that need to be taken to strengthen the foundation of the

banking system and structural changes in the system suggested capital adequacy, asset quality,

prudential norms, systems and methods in banks.

6. RBI Panel on DRT’s (1998) The RBI had set up Working Group in the month of March 1998

to review the functioning of Debt Recovery Tribunals under the Chairmanship of Shri N.V.

Deshpandey. The objectives of the panel were to look into various issues and problems

confronting the functioning of DRTs in expeditious recovery of banks dues and to examine the

existing statutory provisions and suggest necessary amendments to the Recovery of Debts due to

Banks and Financial Institutions Act, 1993 and Rules framed there under with a view to

improving efficacy of legal machinery.

7. Special Report on NPA by RBI (July 1999) In order to study some aspects and issues

relating to NPAs in Commercial Banks, RBI has prepared a report in the Department of Banking

Supervision. Shri A.Q.Siddiqui, Chief General Manager, was in charge of this project whereas,

Shri A.S. Rao and R.M. Thakkar, both Deputy General Managers, assisted this project. This

study has been carried out using the RBI inspection reports on Banks, information / data obtained

from public sector banks and 6 private sectors banks and those collected from the files on

borrowable accounts maintained in banks for assessing comparative position on NPAs and their

recoveries in banks. The causes for sickness /weak performance and consequently the account

turning NPA in respect of Public sector banks and private sector banks.

2.5. Conclusions

In this Chapter, attempt is made to learn in brief, purpose, terms of reference and findings of

various Committees, Study Groups, and Research work relating to the task of Credit, Legal

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Reforms and NPAs which is very useful in this present research study. All these tasks are

discussed in detail in following Chapters where ever applicable.

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COMPARATIVE STUDY WITH OTHER COUNTRIES AND SCOPE OF THE STUDY

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3.1 Comparative Study With Other Countries:

I. China: (a) Causes: (i) The State Owned Enterprises (SOE’s) believe that there the government

will bail them out in case of trouble and so they continue to take high risks and have not really

strived to achieve profitability and to improve operational efficiency. (ii) Political and social

implications of restructuring big SOE’s force the government to keep them afloat,(iii) Banks are

reluctant to lend to the private enterprises because while an NPA of an SOE is financially

undesirable, an NPA of a private enterprise is both financially and politically undesirable,(iv)

Courts are not reliable enforcement vehicles.

(b) Measures: (i) Reducing risk by strengthening banks, raising disclosure standards and

spearheading reforms of the SOE’s by reducing their level of debt, (ii) Laws were passed

allowing the creation of asset management companies, foreign equity participation in

securitization and asset backed securitization, (iii) The government which bore the financial loss

of debt ‘discounting’. Debt/equity swaps were allowed in case a growth opportunity existed, (iv)

Incentives like tax breaks, exemption from administration fees and clear cut asset evaluation

norms were implemented. The AMCs have been using leases, transfers, restructuring, debt- for-

equity swaps and asset securitization, among other methods, to dispose of non-performing loans

II. Korea: (a) Causes: (i) Protracted periods of interest rate control and selective credit

allocations gave rise to an inefficient distribution of funds,(ii) Lack of Monitoring ..... Banks

relied on collaterals and guarantees in the allocation of credit, and little attention was paid to

earnings performance and cash flows,

(b) Measurers: (i) The speedy containment of systemic risk and the domestic credit crunch

problem with the injection of large public funds for bank recapitalization, (ii) Corporate

Restructuring Vehicles (CRVs) and Debt/Equity Swaps were used to facilitate the resolution of

bad loans, (iii) Creation of the Korea Asset Management Corporation (KAMCO) and a NPA

fund to fund to finance the purchase of NPAs, (iv) Strengthening of Provision norms and loan

classification standards based on forward-looking criteria (like future cash flows) were

implemented; (v) The objective of the central bank was solely defined as maintaining price

stability. The Financial Supervisory Commission (FSC) was created (1998) to ensure an

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effective supervisory system in line with universal banking practices.

III. Japan: (a) Causes: (i) Investments was made real estate at high prices during the boom. The

recession caused prices to crash and turned a lot of these loans bad, (ii) Legal mechanisms to

dispose bad loans were time consuming and expensive and NPAs remained on the balance sheet,

(iii) Expansionary fiscal policy measures administered to stimulate the economy supported

industrial sectors like construction and real estate, which may further exacerbated the problem,

(iv) Weak corporate governance coupled with a no-bankruptcy doctrine, (v) Inadequate

accounting systems.

(b) Measures: (i) Amendment of foreign exchange control law (l997) and the threat of

suspension of banking business in case of failure to satisfy the capital adequacy ratio prescribed,

(ii) Accounting standards – Major business groups established a private standard-setting vehicle

for Japanese accounting standards (2001) in line with international standards, (iii) Government

Support - The government’s committed public funds to deal with banking sector weakness.

III. Pakistan: (a) Causes: (i) Culture of "zero equity" projects where there was minimal due

diligence was done by banks in giving loans coupled with collusive lending and poor corporate

governance, (ii) Poor entrepreneurship, (iii) Chronic over-capacity/lack of competitive

advantage,(iv) Directed lending where the senior management of the public sector banks gave

loans to political heavy weights/ military commanders.

(b) Measures: (i) The top management of the banks was changed and appointment of

independent directors in the board of directors , (ii) aggressive settlements were done by banks

with their defaulting borrowers at values well below the actual debt outstanding and/or the

amount awarded through the court process ..... i.e., large haircuts/ write offs, (iii) setting up of

Corporate and Industrial Restructuring Corporation (CIRC) to take over the non-performing loan

portfolios of nationalized banks on certain agreed terms and conditions and issue government

guaranteed bonds earning market rates of return,(iv) The Banking Companies (Recovery of

Loans, Advances, Credits and Finances) Act, 1997 was introduced in February 1997.

3.2 The Need for the Study

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Need for the research study after observation that generally the authors take separately Public

Sector Banks, Private Sector Banks and Cooperative Bank. Indeed the researcher have noticed

similarities and dissimilarities in these banks and also would like to perform detailed study on

NBFC along with these sectors and compare their NPA level and their success.NPA is not only

in Indian scenario but it is also existing in foreign countries. Inspite of legal frame work and

regulatory have been appointed still NPA exist. As the need of time to regain trust in all the

sectors of as well as the Financial Institution the detailed comparative analysis on policies, Cause

for NPA at different stage and level of NPA on priority, Non priority and SSI has been selected.

Many of the researchers studied the related topic only on Commercial banks or separately on

Private Banks or exclusively on Co operative Banks. It is necessary to do the comparative

analysis on all the sectors to get a fair view of these related issues.

3.3 Statement of the Problem

The study relates with the credit advances and recovery of loans by banks and financial

institutions. Recovery of loan is very important in the success of performance of individual

banks as well as sectors as a whole. Failure to recover leads to overdues by the borrower. The

research study has been carried out to find out the measure to reduce the bad loans in different

sectors and the techniques to control the level of bad loan in banking sectors and Financial

Institution. In the era of globalization the entire banking sector and financial institution is facing

lot of problem. These problems include severe competitions, advanced technology, modern

management methods etc. To reduce the bad loan or nonperforming assets efficient and

standardised activities must be adopted. Bad loans and nonperforming assets can be implemented

only after realising deficiency in the existing system. Hence the strength and weakness can be

studied by comparative analysis in the entire banking system. The researcher has tried to analyse

the gaps in each sector on financial and non financial issues.

3.4 Objectives of Study:

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To identify and analyze the trends of loans and advance with respect to Public sector

banks, Private sector banks, Co operative sector banks and Financial Institutions in

India.

To understand the cause and factors that are responsible for lower profitability and

operational efficiency &improve the same.

To analyze, the trend of NPA’s & profitability of banks of Public sector banks,

Private sector banks, Co operative sector and Financial Institutions.

Measures to reduce existing NPAs with respect to different sectors.

To suggest improvement in monitoring and reducing the overdue

3.5 Limitation of the Study

The study suffers from the limitations which are inherent due to economic value and not physical

value. The study is based on primary data which carries its own limitations. The analysis is based

on data published by banks submitted to RBI. The cooperative banks are spread over widely it is

not possible to cover majority of the cooperative banks. Cooperative banks are further classified

into State Cooperative Banks, Schedule Cooperative Banks, District Cooperative Banks, Local

cooperative banks and Bhatti petti. The data is related to last 10 years only. The research study

mainly is based on Scheduled Urban Cooperative banks. The study concentrated only on non

performing assets and related issues. The study is a combination of explanatory and empirical.

3.6 Methodology of the study:

Methodology relates to plan of study, which includes steps of data collection, types of

Questionnaire, process of data and finally interpretation of data Data is collected from public

Sector Banks, Private Sector Banks, and Scheduled Urban Co-operative Sector Banks and NBFC

a. Primary Data: The Primary data is collected through Questionnaire, which is divided into two

parts:

a. Questionnaire which deals with the general policy of the banks

b. Annexure questionnaire is divided into three stages viz:

PART-A : APPRAISAL STAGE

PART B: SANCTION & DISBURSEMENT STAGE

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PART C : POST DISBURSEMENT STAGE

i. Primary data was collected through unstructured Interviews with Bank Officials from

Public Sector Banks, Private sector Banks, and Scheduled Urban Cooperative Banks

& Financial institution. Their views regarding NPA was collected

ii. Opinions of Banks Facilitators (Chartered Accountant, Advocates, Industrial

borrowers, Individual Borrowers, Collection Agents).

3.7 Conclusion

The distribution of NPAs in the system follows 80-20 rule whereby 20% by number of

borrowers are responsible for 80% of value of impaired assets and conversely. The large

impaired assets comprise industrial assets having good restructuring potential Arcil experience

shows in value terms more than 60% of the impaired assets are amenable to be restructured or

sold as a going concern. The small assets however have to be put through a recovery process,

where the collateral based financing system followed in the country offers a fair recovery

potential. The seed of success of managing the impaired asset in any economy lies in the speed

of recycling these assets and their realization into cash. In achieving objective the legal

environment should adequately possess empowered system and structure, support from the

government and finally accessibility to new domestic and foreign capital. Only then Indian

banking shall be in full throttle to take up on the challenge to de-stress the system and prepare for

future growth by fueling the SMEs which is the growth engine for Indian economy in the future

era. The long tradition of political consensus with required legislation, fund support and prompt

action helped to resolve the crisis minimising the loss. It is preferable to opt for a structured

model to handle risky capital separately. The crucial factor is to quickly identify the problem and

approach professionally utilising the lessons from the past experience prudently and

pragmatically.

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LEGAL FRAME WORK AND NOTIFICATION

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4.1 Introduction

Globalization has resulted into the rapid transformation of the financial system all over the

world. As a result capital market, money market and debt market are getting widened deepened.

The growth of financial market has increased the need for innovative instruments for raising

funds. There is increasing from investors, for high quality, low risk securities. Today the

toughest problem faced by the entire banking industry in India is the NPAs, i.e. the loans, where

the principal and interest cannot be recovered, thus the assets stop earning any income. The

unbearable level of NPAs has led to lower interest income and loan loss provisioning

requirements which have destroyed the profitability of the banks to great extent. Besides the

recycling of funds is restricted, thus leading to serious asset liability mismatches. The supply of

credit to potential borrowers have been blocked which is having a harmful effect on the capital

formation and hampering the economic activity of the country. So the NPA problem is an issue

of public debate and of national priority.

India’s legal system has traditionally been friendly towards borrowers and famously slow and

inefficient. In 1993, Debt Recovery Tribunal (DRTs) was set up precisely to avert the said

problem, to give bank faster access to justice. In 2002, a major step in empowering banks in their

loan recovery effort came in the form of the NPA Ordinance, later turned into the Securitization

and Reconstruction of Financial Assets and Enforcement of security Interest (SARFAESI) Act.

The Act paves the way for the establishment of Assets Reconstruction Companies (ARCs) that

can take the NPAs off the balance sheets of banks and recover them.

4.2 Purpose of the Act

Securitization, the process of converting illiquid loans into tradable securities, has emerged as an

important tool for financing worldwide. Securitization has gained increased acceptance in India

over the years. Securitization emerged as an important tool for fund raising by Indian Banks and

non banking financial institutions. Success of securitization depends upon proper implementation

of the Act. Priority sector lending requirement of Indian bank was the key driver behind the retail

securitization transaction during 2009.A majority of the retail loan pools securitised in 2009 were

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backed by priority sector loan originated by NBFCs. Transactions through direct assignment

route dominated the market in 2009, as this route facilitates the transfer of priority sector loans

directly to the acquirer’s loan book instead of investment book and thereby fulfilling priority

sector lending requirement.

4.3 The Securitisation and Reconstruction of Financial Assets and Enforcement of Security

Interest Act, 2002 - An Overview of the Provisions.

Financial indiscipline is the hallmark of Indian industry. The ever-growing Non-Performing

Assets ('NPA'), a fine euphemism coined to describe the bad loans, prompted the passing of the

Recoveries of Debts due to Banks and Financial Institutions Act, 1993 whereby a special Debt

Recovery Tribunal ('DRT') was set up for the recovery of NPA. However, this could not speed

up the recovery on one hand and on the other the strict civil law requirements rendered almost

futile the attachment and foreclosure of the assets given as security for the loan. Further, the

balance sheets of the banks and financial institutions were turning red due to heavy mandatory

provisions for NPAs .

Realizing that every fifth borrower is a defaulter, the Government was under pressure to make

adequate provisions for the recovery of the loans and also to foreclose the security. The

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act,

2002 ('the Securitisation Act') aims to achieve these twin objectives besides providing for a

broad legal framework for asset securitisation and asset reconstruction.

Scheme of the Act

The Securitisation Act contains 41 sections in 6 Chapters and a Schedule. Chapter 1 contains 2

sections dealing with the applicability of the Securitisation Act and definitions of various terms.

Chapter 2 contains 10 sections providing for regulation of securitisation and reconstruction of

financial assets of banks and financial institutions, setting up of securitisation and reconstruction

companies and matters related thereto. Chapter 3 contains 9 sections providing for the

enforcement of security interest and allied and incidental matters. Chapter 4 contains 7 sections

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providing for the establishment of a Central Registry, registration of securitisation,

reconstruction and security interest transactions and matters related thereto. Chapter 5 contains 4

sections providing for offences, penalties and punishments. Chapter 6 contains 10 sections

providing for routine legal issues.

Salient features.

The salient features of the Securitisation Act are as under:

Incorporation of Special Purpose Vehicles viz. Securitisation Company and

Reconstruction company.

Securitisation of Financial Assets.

Funding of securitisation.

Asset Reconstruction.

Enforcing security interest i.e. taking over the assets given as security for the loan.

Establishment of Central Registry for regulating and registering securitisation

transactions.

Offences & Penalties.

Boiler - plate provisions.

Dilution of provisions of SICA.

Exempted transactions

Incorporation & Registration of Special Purpose Companies

The Securitisation Act proposes to securitise and reconstruct the financial assets through two

special purpose vehicles viz. 'Securitisation Company ('SCO')' and 'Reconstruction Company

(RCO)'. SCO and RCO ought to be a company incorporated under the Companies Act,1956

having securitisation and asset reconstruction respectively as main object.

The Securitisation Act requires compulsory registration of SCO and RCO under the

Securitisation Act before commencing its business. Further a minimum financial stability

requirement is also provided by requiring SCO and RCO to possess owned fund of Rs.2 crore or

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up to 15% of the total financial assets acquired or to be acquired. The RBI has the power to

specify the rate of owned fund from time to time. Different rates can be prescribed for different

classes of SCO and RCO. Existing SCO and RCO are also required to get registered under the

Securitisation Act. The application for registration will have to be made to RBI.

The SCO or RCO which has obtained the registration certificate under the Securitisation Act

shall be a Public Financial Institution within the meaning of Section 4A of the Companies Act,

1956.

Besides it's core business of securitisation and asset reconstruction a SCO/RCO may perform the

following functions:

Acting as recovery agent on behalf of any bank or financial institution.

Acting as manager1 to manage the secured assets the possession of which has been taken

over by the secured creditor.

Acting as receiver if appointed by any Court or Debt Recovery Tribunal.

A SCOO or RCOO, which is carrying on any other business other than that of securitisation or

asset reconstruction before commencement of the Securitisation Act, has to discontinue such

other business within one year from the commencement of the Securitisation Act.

Securitisation of financial Assets

Under the Securitisation Act only banks and financial institutions can securitise their financial

assets pertaining to NPAs with a securitisation company. Securitisation means, according to the

Securitisation Act, acquisition of financial assets by any securitisation company or reconstruction

company from any financial institution or banks. The necessary funds for such acquisition may

be raised from 'qualified institutional buyers ('QIB')'2, by issuing security receipts3 representing

undivided interest in such financial assets or other wise.

Financial assets are as under:

A claim to any debt or receivables or part thereof, whether secured or unsecured.

Any debt or receivables secured by, mortgage of, or charge on, immovable property.

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A mortgage, charge, hypothecation or pledge of movable property.

Any right or interest in the security whether full or part underlying such debt or

receivables.

Any beneficial interest in property, whether movable or immovable, or in such debts,

receivables, whether such interest is existing, future, accruing, conditional or contingent.

Any financial assistance.

The much-needed legal framework for the securitisation of financial assets has been made by the

enactment of the Securitisation Act. Securitisation of financial assets is a financial tool for the

lenders to securitise their future cash flows from the secured assets and thus to release their funds

blocked in them. In the hands of the SCO and RCO the secured assets become "merchandise",

realisation of which gives them their return. This aspect brings in the much-needed expertise in

adept handling in realisation of the secured assets. The legal impediments of normal civil law

procedure to foreclose the mortgaged assets have thus been effectively removed by empowering

the enforcement of the secured assets.

Securitisation of financial assets may take some time to fructify as it requires sound accounting

principles also for which standards to be prescribed. In other words there should be accounting

framework, as well, besides legal framework.

Acquisition of Rights and interests in financial assets.

This is the main part of securitisation. Section 5 provides for the acquisition of rights or interests

in financial assets of any bank or financial institution by SCO / RCO, notwithstanding any thing

contrary contained in any agreement or any other law for the time being in force, in either of the

following manner:

Issuing a debenture or bond or any other security in the nature of debenture, as

consideration agreed upon by a SCO /RCO and bank/financial institution, incorporating

therein the terms and conditions of issue.

Entering into an agreement with bank/financial institution for the transfer of such

financial assets on such terms and conditions as may be agreed upon.

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Upon acquiring the financial assets from the bank/financial institution, the SCO/RCO steps into

the shoes of the lender qua the borrower. The Securitisation Act has provided for all necessary

rights and powers for SCO/RCO to realize the financial assets from the borrower.

Funding of Securitisation.

The SCO/RCO may raise the necessary funds, for the acquisition of financial assets, from the

QIB by issuing a security receipt. Security receipt is exempted from compulsory registration

under the Registration Act. Security receipts issued by any SCO or RCO shall be "securities"

within the meaning of Section 2(h)(ic) of the Securities Contracts (Regulation) Act, 1956.

A Scheme of acquisition has to be formulated for every acquisition detailing therein the

description of financial assets under acquisition, the quantum of investment, rate of return

assured etc. Further separate and distinct accounts have to be maintained in respect of each

scheme of acquisition. Realizations made from the financial assets have to be held and applied

towards the redemption of investments and payment of assured returns.

In the event of non-realization of financial assets, the QIB holding not less than 75% of the total

value of the security receipts issued, are entitled to call a meeting of all QIB and pass resolution

and every such resolution is binding on the SCO/RCO.

Assets Reconstruction

A SCO or RCO may, according to the guidelines prescribed by RBI, carry out asset

reconstruction in any one of the following manners:

Taking over the management of the business of the borrower.

Changing the management of the business of the borrower.

Selling or leasing of a part or whole of the business of the borrower.

Rescheduling of the payment schedule of the debt.

Enforcing the security interest.

Entering into settlement with the borrower for the payment of debt.

However, the above measures are subject to the provisions contained in any other law for the

time being in force.

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Enforcing Security Interest

The second objective of the Securitisation Act is to provide for the enforcement of security

interest i.e. taking possession of the assets given as security for the loan. Section 13 of the

Securitisation Act contains elaborate provisions for a lender (referred to as 'secured creditor') to

take possession of the security given by the borrower. The sum and substance of the provisions

are as under:

The Lender has to send a notice of demand, giving details of the amount payable and the

secured assets intended to be enforced in the event of non payment, to the defaulting

borrower to discharge his liabilities.

No borrower, after the receipt of the demand notice, shall transfer the secured assets in

whatsoever manner without prior written consent from the lender.

The Borrower has to discharge the liabilities within 60 days from the date of receipt of

notice of demand.

In the event of non payment of demand by the borrower, the lender may take any one or

more of the following measures:

o Taking possession and / or management of the secured assets of the borrower with

a right to transfer the same by way of lease, assignment or sale for realising the

secured asset.

o Appointing any person as manager to manage the secured assets the possession of

which has been taken over.

o Asking any person, who has acquired any of the secured assets from the borrower

and owes money to the borrower, to pay so much of the money which is sufficient

to pay the secured debt.

Any transfer of secured assets made by the lender shall be deemed to be made by the

owner of such secured asset.

If the borrower pays all the dues together with all costs, charges and expenses incurred by

the lender before the date fixed for the sale of the secured assets, the lender shall not

transfer or sell the secured assets.

When the are more than one lender or joint financing, the approval of lender(s)

representing not less than 75% of the amount due is required to take any steps to enforce

the security interest and such approval is binding on all the lenders.

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In the case of a corporate borrower under liquidation the sale proceeds from the secured

assets shall be distributed as per Section 529A of the companies Act, 1956.

In the event of lender opts to realise his security instead of relinquishing his security and

proving his debt, may retain the sale proceeds of his secured assets after depositing the

workmen's dues with the Liquidator.

If the sale proceeds of the secured assets are not fully satisfying the debt due, the lender

may file a claim before the DRT or before a competent court for the recovery of the

shortfall.

The lender also has an option to proceed against any of the guarantors or sell the pledged

assets without taking any measures against the borrower.

The lender can take the assistance of the Chief Metropoliton Magistrate or District

Magistrate, as the case may be, in taking possession of the secured assets from the

borrower.

If any person, including the borrower, is aggrieved by any of the measures adopted by the

lender, he may prefer an appeal to the DRT within 45 days by depositing atleast 75% of

the claim of the lender. The decision of the DRT is further appealable to an Appellate

Tribunal.

The lender can initiate any proceedings to enforce the security interest unless his claim of

the financial asset is made within the period prescribed under the Limitation Act, 1963.

Enforcement of security interest has taken a flying start. It is pertinent to mention here that ICCI

(having NPA of Rs.6918 Crore) and IDBI (having NPA of Rs.13297 Crore) has already taken

measures under the Securitisation Act, against 20 corporate houses, to enforce their security

interest6. Many banks and financial institutions may follow suit.

Establishment of a Central Registry

The functions relating to securitisation, asset reconstruction and creation of security interest is

sought to be administered and regulated by a Central Registry. Branch offices of the Central

Registry may be established as and when the need is required. A Central Registrar shall head the

Registry. The functions of the Central Registry are as under:

Particulars relating to securitisation of assets, reconstruction of financial assets and

creation of security interest are entered in a record called Central Register.

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The records can be kept in electronic form also i.e. in floppies, diskettes etc.

The particulars of every transaction of securitisation, asset reconstruction or creation of

security interest shall be filed within 30 days of the transaction by SCO, RCO or the

lender as the case may be.

Modifications made in the security interest registered with the Registry are to be filed

within 30 days of such modification.

Satisfaction of security interest is required to be filed with the Registry within 30 days of

satisfaction.

Records maintained at the Central Registry are open to inspection for any person on

payment of the prescribed fee.

Offences & Penalties

Following are the offences prescribed under the Securitisation Act:

Default in filing particulars of transactions relating to asset securitisation, asset

reconstruction and creation of security interest.

Default in filing particulars of modification.

Default in giving intimation of particulars satisfaction.

Non-compliance of RBI directives by SCO and RCO.

Contravention, including attempt to contravene and abetting in contravention, of any of

the provisions of the Securitisation Act or any rules made thereunder.

Following are the penalties prescribed in the Securitisation Act:

For default in filing particulars of transactions mentioned above, every company and

every officer of the company or every lender or officer of the lender shall be punished

with a fine which may extend to Rs.5000/- for every day during which the default

continues.

For non-compliance of RBI directives every company and every officer of the company

shall be punished with a fine which may extend to Rs.5, 00,000/-; and for continuing

offence an additional fine of Rs.10, 000/- for every day during which the default

continues.

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For contravention of any provisions of the Securitisation Act, the punishment is

imprisonment for a term which may extend to one year, or with a fine, or with both.

Only a Metropolitan Magistrate or Judicial magistrate of the First Class has powers to take

cognizance and try an offence under the Securitisation Act.

Boiler-plate Provisions

The following are the general provisions of the Securitisation Act:

The matters, over which DRT or Appellate Tribunal has jurisdiction under this

Securitisation Act, shall not be tried by any Civil Court.

The provisions of the Securitisation Act shall override the provisions of other laws or any

instruments.

However the provisions of the Securitisation Act are in addition to and not in derogation

of the following enactments:

o The Companies Act, 1956.

o The Securities Contracts (Regulation) Act, 1956.

o The Securities and Exchange Board of India Act, 1992.

o The Recovery of Debts due to Banks and Financial Institutions Act, 1993.

The Central Government has powers to make rules for carrying out the provisions of the

Securitisation Act.

Since the Central Registry is not yet established, the provisions relating to the Central

Registry shall be applicable after the setting up of the Central Registry.

Dilution of provisions of SICA.

The protective umbrella of registering with BIFR under Sick Industrial Companies (Special

Provisions) Act 1985('SICA'), which has hitherto encouraged industrial sickness, has been

removed by inserting two provisos in Section 15 of the SICA.they are as under:

After the commencement of the Securitisation Act, where any SCO or RCO has acquired

financial assets, no reference shall be made to BIFR.

After the commencement of the Securitisation Act, any pending reference before BIFR

shall come to an end where secured creditors, representing not less than 75% of the value

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of the amount outstanding, have taken any measures to recover their secured debts under

the provisions of the Securitisation Act.

Exempted transactions

The following transactions are exempted from the provisions of the Securitisation Act:

Lien on any goods, money or securities given under the Contract Act,1872.

Pledge of movables under the Contract Act,1872.

Creation of security on aircraft.

Creation of security interest on vessel.

Conditional sale, hire-purchase or lease in which no security interest is created.

Rights of unpaid seller under the Sale of Goods Act,1930.

Non attachable properties under the civil Procedure Code.

Security interest on an amount less than or equal to Rs.1 lakh.

Security interest created on agricultural land.

Amount due is less than 20% of the principal sum and interest thereon.

4.4 DEBT RECOVERY

A bank begins a debt recovery process when it seeks money it is owed. A bank takes recovery

action for a number of reasons, but the most common is when a customer fails to make loan

repayments.

Debt recovery may include:

Referring the matter to a specialist debt recovery team within the bank

Employing an external debt collection agency to act on its behalf

Selling property over which the bank holds security

Seeking a judgment from the courts to enforce the debts

Why timely recovery of loans is important

Timely recovery of a normal loan between two parties may not be of critical importance to

anyone, except to those two. A bank loan is not just a contract between the bank and the

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borrower. Entwined with this contract is the general welfare of the public, out of whose deposits

the bank loan has been granted. However, timely recovery of bank loans are important for

variety of reasons and from various perspectives. From the borrower’s angle, the longer the delay

in settlement, the outstanding liabilities of the borrower increase; the likely penalties may also

increase with time. From the bank’s perspective, the longer the delay in recovery, they lose the

opportunity to earn income in alternative investments, the security and collateral may lose value

and hence may incur capital loss as well. More importantly, the delays in recovery proceeds can

lead to liquidity crisis in the bank, run on the bank and consequent failure of the bank. From the

society’s angle, the productive assets are held up, not producing value, not creating employment

and income. From the government’s perspective, if such loan losses cascade and turn into

systemic risk and endanger the financial and economic stability, the tax payers’ money will have

to be used up for rescuing these banks, otherwise the depositors, meaning the ordinary, general

public will have to bear losses. Thus from very many perspectives, timely recovery of loans are

critical for the borrower, the bank, the society and the government.

Restructuring a Bank Loan

Recognising the importance of contribution of productive assets for generating employment,

income and value, banks world over are expected to have forbearance towards loans for those

assets. In many countries, banks are, by law and/or regulations, required to show such

forbearance. In India also such provisions exist in law and regulations. SICA, BIFR, CDR, JLF

and several other regulations of the Reserve Bank are the examples. Viable businesses, though

not repaying the loans, are required to be supported by the banks; variety of concessions are

being extended by the banks; the concessions include additional moratorium, elongated

repayment schedules, lower interest rates, write offs and waiver of interest, penalties, charges

and even principal etc. Compromised settlements are common for almost every type of loans.

Thus the banks do not proceed to recovery of bank loans just like that. As mentioned, they have

to first establish the possibility of restructuring and restoration, before initiating recovery

proceedings.

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Recovery through Debt Recovery Tribunals (DRTs)

The Reserve Bank, along with the Government, has initiated several institutional measures to

speed up recovery of bank loans. Prior to 1993, banks had to take recourse to the long legal route

against defaulting borrowers, beginning with the filing of claims in the courts. Many years were

therefore spent in the judicial process before banks could have any chance of recovery of their

loans.

The Committee on the financial system headed by Shri M. Narasimham had recommended

setting up of the Special Tribunals with special powers for adjudication of such matters and

speedy recovery as critical to the successful implementation of the financial sector reforms.

Another Committee under the Chairmanship of Shri T. Tiwari had examined the legal and other

difficulties faced by banks and financial institutions and suggested remedial measures including

changes in law.

Debt Recovery Tribunals (DRTs) were established consequent to the passing of Recovery of

Debts Due to Banks and Financial Institutions Act, 1993 to assist the banks in the speedy

adjudication of matters relating to recovery of NPAs of `10 lakh and above. Appeals against

orders passed by Debts Recovery Tribunal (DRT) lie before Debts Recovery Appellate Tribunal

(DRAT).

Presently, there are 33 DRTs and 5 DRATs functioning all over the country. The recent

amendments to DRT Act vide the Enforcement of Security Interest and Recovery of Debts Laws

(Amendment) Act, 2012 have been carried out to improve the functioning of the DRTs, to

prescribe time frame for filing of pleadings, adjournments etc. and to give recognition and

validity to the settlements / compromises entered into between banks and borrowers.

Within a lesser period than a decade it was observed that DRTs could not give desired results

and a need was felt that banks should be given adequate powers to recover their dues without

intervention of Courts and Tribunals. SARFAESI Act was brought into existence in 2002. It was

indeed a good piece of legislation which gives adequate strength to the Banks and Financial

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Institutions to expedite recovery of their dues but clever defaulters found their ways to move the

Court / Debt Recovery Tribunal to delay the course of recovery and entangle the banks with

endless litigation. SARFAESI Act was enacted to avoid going to DRTs but banks get dragged to

DRTs on flimsy grounds.

The Government has formed a committee to examine the need for strong Bankruptcy law.

Asset Quality

The gross NPAs to gross advances of scheduled commercial banks have increased from 3.4 per

cent as at end March 2013 to 4.1 per cent as at end March 2014. During the same period net

NPAs to net advances increased from 1.7 per cent to 2.2 per cent. The gross NPAs were ` 2,511

billion as on March 31, 2014 as compared to ` 1,839 billion as on March 31, 2013. Banks’ ratio

of restructured assets to gross advances stood at 5.9 per cent as of the end of March 2014,

compared with 5.8 per cent a year ago. In absolute terms, the restructured assets amounted to `

3,579 billion as at end of March 2014. Thus the total stressed assets, meaning the loans which are

not being recovered despite having become due, amounted to ` 6,090 billion as at the end of

March 2014, as against total gross advances of ` 61,018 billion as on that date.

These data should be seen in the light of the total capital and profits of the banks. The total

capital amounted to ` 7,278 billion as at end March 2014 and the total profits in 2013-14 were `

722 billion during 2013-14. It can be seen easily the extent of damage that can happen to the

profitability, liquidity and solvency of banks, if timely recovery of such large amount of stressed

assets do not materialise.

Regulatory Measures

Reserve Bank has been making constant efforts to enable banks to improve the quality of

lending. Information sharing is very critical in financial transactions and any gap in information

can transform into risk cost for the bank. This entails significant consequences for lending as it

results in misallocation of credit. Keeping in view the importance of credit discipline for

reduction in NPA level of banks, banks have been advised to scrupulously ensure that their

branches do not open current accounts of entities which enjoy credit facilities (fund based or

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non-fund based) from other banks without specifically obtaining a No Objection Certificate from

the lending bank(s). Banks should take a declaration to the effect, if the account holder is not

enjoying any credit facility with any other bank.

Credit Information Companies (CICs) play a major role in information sharing. Banks and

Financial Institutions are required to submit the list of suit-filed accounts and wilful defaulters of

` 25 lakh and above every quarter to CICs. CICs have also been advised to disseminate the

information pertaining to suit filed accounts and Wilful Defaulters on their respective websites.

After examining the recommendations of the Committee to Recommend Data Format for

Furnishing of Credit Information to Credit Information Companies (Chairman: Shri Aditya Puri),

banks / Financial Institutions have been advised to furnish the data in respect of wilful defaulters

(nonsuit filed accounts) of ` 25 lakhs and above to CICs on a monthly or a more frequent basis

with effect from December 31, 2014. This would enable such information to be available to the

banks / Financial Institutions on a near real time basis.

The Central Electronic Registry under SARFAESI Act has become operational on March 31,

2011 with the objective of preventing frauds in loan cases involving multiple lending from

different banks on the same immovable property. Initially transactions relating to securitization

and reconstruction of financial assets and those relating to mortgage by deposit of title deeds to

secure any loan or advances granted by banks and financial institutions, as defined under the

SARFAESI Act, are to be registered in the Central Registry. The records maintained by the

Central Registry will be available for search by any lender or any other person desirous of

dealing with the property. Availability of such records would prevent frauds involving multiple

lending against the security of same property as well as fraudulent sale of property without

disclosing the security interest over such property.

Despite the information sharing mechanisms as detailed above, if the loans still go bad,

restructuring mechanisms have been spelt out to help a borrower who has a viable project or a

viable business proposition. With a view to putting in place a mechanism for timely and

transparent restructuring of corporate debts of viable entities facing problems, a Scheme of

Corporate Debt Restructuring (CDR) was started in 2001 for quicker recovery/ restructuring of

stressed assets.

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In the backdrop of the slowdown of the Indian economy resulting into stress to a number of

companies / projects and increase in Non-Performing Assets (NPAs) and restructured accounts in

the Indian banking system during the recent years, a need was felt to recognise the stress in the

economy early on a real time basis and take preventive and / or corrective actions in order to

preserve the economic value of banks’ assets. In view of this, the Reserve Bank envisaged and

released the ‘Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair

Recovery for Lenders: Framework for Revitalising Distressed Assets in the Economy’ on

January 30, 2014. The framework outlines a corrective action plan to incentivise: (i) early

identification of problematic accounts, (ii) timely restructuring of accounts that are considered to

be viable, and (iii) lenders taking prompt steps for recovery or sale of unviable accounts.

The Framework outlines an early recognition of stress in all large value accounts and their

reporting to a centralised repository at the RBI for dissemination among all the concerned

lenders for taking corrective actions as per the broad guidelines given in the Framework.

Accordingly, a Central Repository of Information on Large Credits (CRILC) has been set up in

April 2014 to collect, store, and disseminate credit data to lenders. Banks are required to furnish

credit information to CRILC on all their borrowers having aggregate fund-based and non-fund

based exposure of ` 50 million and above with them. Notified systemically important non-

banking financial companies (NBFC-SI) and NBFC-Factors would also be required to furnish

such information. CRILC’s essential objective is to enable banks to take informed credit

decisions and early recognition of asset quality problems by reducing information asymmetry.

Banks are also required to monitor both qualitative and quantitative stress building up in their

large accounts at an early stage under three categories of Special Mention Accounts (SMA), viz.,

SMA-0, SMA-1 & SMA-2. While, SMA – 1 and 2 will be based on past due criteria, SMA – 0

will contain non-past due qualitative and quantitative stress in the account.

Once an account is reported to CRILC as SMA – 2, lenders will be required to form a Joint

Lenders Forum (JLF) and take prompt corrective action. The corrective action plan (CAP)

includes (a) Rectification (b) Restructuring and (c) Recovery. Restructuring can be carried out

either under the corporate debt restructuring mechanism or under JLF, but if not found to be

feasible, JLF will initiate recovery measures. JLF formation will be mandatory for distressed

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borrowers, engaged in any type of activity, with aggregate fund based and non-fund based

exposure (AE) of ` 1000 million and above. Non-adherence to regulatory guidelines has been

disincentivised by way of accelerated provisioning.

Since in terms of Section 128 of the Indian Contract Act, 1872, the liability of the surety is

coextensive with that of the principal debtor, when a default is made in making repayment by the

principal debtor, the banker will be able to proceed against the guarantor / surety even without

exhausting the remedies against the principal debtor. As such, where a banker has made a claim

on the guarantor on account of the default made by the principal debtor, the liability of the

guarantor is immediate. In case the said guarantor refuses to comply with the demand made by

the creditor / banker, despite having sufficient means to make payment of the dues, such

guarantor would also be treated as a wilful defaulter.

A non-cooperative borrower is one who does not engage constructively with his lender, by

defaulting in timely repayment of dues while having ability to pay, thwarting lenders’ efforts for

recovery of their dues, not providing necessary information sought, denying access to assets

financed / collateral securities, obstructing sale of securities, etc. In effect, a non-cooperative

borrower is a defaulter who deliberately stone walls legitimate efforts of the lenders to recover

their dues. Higher capital and higher provisioning would be required in further lending to these

borrowers.

Role of DRTs in the Financial Sector

The expectation from DRTs and DRATs is very high. This is so because these institutions were

set up for a specific purpose. The underlying purpose is improving credit culture. If the borrower

gets the message that he cannot delay recovery and get away with it, repayment culture is

expected to improve. That will provide more funds to lend. If the cycle of lending and recovery

goes on smoothly, the economy will grow. In this process DRTs and DRATs have a very big role

to play.

It is not suggested that all judicial and legal principles should be dumped for improving recovery.

In majority of cases our understanding is that there is no doubt that the money has been lent and

not repaid. When the bank lends money, it pays through banking channels and when recovery is

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made it also comes through banking channels. Thus documentary evidence is easily discernable.

In such transactions processed through banking channels there is hardly any doubt about the fact

of lending and recovery. There could be disputes about calculation or some technicalities. If they

are not allowed to be blown out of proportion, it is believed that delays can be avoided. Even if

undisputed portion of loan is required to be paid forthwith by DRTs and DRATs, that could

contribute in a big way.

The total number of cases filed in DRTs by scheduled commercial banks as a whole up to March

2014 was 1,50,503 and the amount involved was ` 2,601 billion. The total amount recovered up

to March 2014 was ` 427 billion which amounted to only 16.43% of the total amount involved.

Looking at the huge task on hand with as many as 66,971 cases involving ` 1,415 billion pending

before them as on March 31, 2014, Reserve Bank has a lot of expectations from the Debt

Recovery Tribunals. Banks approach DRTs as a last recourse, so cases before DRTs need to be

dealt with more strictly.

We are very much concerned that the sanctity of debt contracts has been continuously eroded in

India, especially by large borrowers. The system protected large borrowers and their right to stay

in control, rendering bankers helpless vis-a-vis large and influential promoters. As explained

earlier, we are separately dealing with this issue through the treatment towards wilful defaulters

and non-cooperative borrowers.

Since pendency of large number of cases in DRTs is one of the prime issues that needs to be

addressed, Some of our other concerns and need for better efficiency of DRTs:

It is understood that in a number of cases, DRT grants time to borrower / applicant to

make payment and subject to payment, bank’s SARFAESI action is stayed and matter

lingers on for a long period.

Though section 17 (5) provides that an application under section 17 shall be disposed of

within 60 days of date of application (extendable up to 4 months) the said time frame is

not being strictly followed in practice. There is long delay in passing orders by the DRTs.

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The officials of DRTs / DRATs should be given proper training so that they appreciate

the very purpose and adjudicate the cases in a way to meet the purpose for which these

Tribunals are established.

As per the RDDBFI Act, though the cases are to be disposed of within six months, in

some cases, the next date itself is given after six months to one year.

When an appeal is filed before DRAT against the order of DRT, though there is provision

for stipulation of deposit of 75% of the amount of debt due as a pre-condition for

admission of appeal, most DRATs are exercising their discretion and do not insist for

deposit of any amount despite the specific pleas made by the bank in this regard.

In many DRTs, even frivolous applications filed by the parties are entertained despite the

fact that the very subject matter does not fall under their jurisdiction. When an

application is filed before the DRT, if they do not have jurisdiction on the subject matter,

on the first day itself, the Presiding Officer is expected to dismiss the petition for want of

jurisdiction so that no time is wasted on those frivolous applications being filed by the

parties only to delay the bank’s recovery process.

Conclusion

To conclude, I do hope that DRTs and DRATs would put their best foot forward in creating an

environment where a healthy, vibrant and sound financial system can be built-up and sustained.

We are also aware of some of the difficulties faced by DRTs and DRATs. We may not be aware

of many others. A workshop like this should help us understand your difficulties also, so that

appropriate solutions can be worked out.

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4.5 Securities Exchange Board of India (SEBI)

SEBI was set up in 1988 to regulate the functions of securities market. SEBI promotes orderly

and healthy development in the stock market but initially SEBI was not able to exercise complete

control over the stock market transactions.

It was left as a watch dog to observe the activities but was found ineffective in regulating and

controlling them. As a result in May 1992, SEBI was granted legal status. SEBI is a body

corporate having a separate legal existence and perpetual succession.

The economy of India is based on sound financial system that helps in accelerating production,

capital and economic growth of the country. The main objectives of every financial system of

modern economy is to accumulate savings and to develop saving habits among the people. It also

helps the saving to allocate into productive usage such as trade and commerce. The optimum and

efficient use and allocation of the savings helps in increasing the economic growth of the

country. Investment is the indicator of the economy level of the country and it is imperative to

protect the interest of the investors.

REASONS FOR ESTABLISHMENT OF SEBI:

With the growth in the dealings of stock markets, lot of malpractices also started in stock

markets such as price rigging, ‘unofficial premium on new issue, and delay in delivery of shares,

violation of rules and regulations of stock exchange and listing requirements. Due to these

malpractices the customers started losing confidence and faith in the stock exchange. So

government of India decided to set up an agency or regulatory body known as Securities

Exchange Board of India (SEBI).

Purpose and Role of SEBI:

Securities Exchange Board of India is mainly concerned with protecting the right of investors

and for this purpose there has been several amendments to the SEBI Act to comply with the

changing need of the capital market. Investors are considered to be the significant component of

the financial market and thus it is the duty of the board to ensure that their rights are protected. In

general parlance investor is the person who invests in business or projects with an intention to

make profit out of the capital incurred by him.

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SEBI was set up with the main purpose of keeping a check on malpractices and protect the

interest of investors. It was set up to meet the needs of three groups.

1. Issuers:

For issuers it provides a market place in which they can raise finance fairly and easily.

2. Investors:

For investors it provides protection and supply of accurate and correct information.

3. Intermediaries:

For intermediaries it provides a competitive professional market.

Objectives of SEBI:

The overall objectives of SEBI are to protect the interest of investors and to promote the

development of stock exchange and to regulate the activities of stock market. The objectives of

SEBI are:

1. To regulate the activities of stock exchange.

2. To protect the rights of investors and ensuring safety to their investment.

3. To prevent fraudulent and malpractices by having balance between self-regulation of

business and its statutory regulations.

4. To regulate and develop a code of conduct for intermediaries such as brokers,

underwriters, etc.

Functions of SEBI:

The SEBI performs functions to meet its objectives. To meet three objectives SEBI has three

important functions. These are:

i. Protective functions

ii. Developmental functions

iii. Regulatory functions.

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1. Protective Functions:

These functions are performed by SEBI to protect the interest of investor and provide safety of

investment.

As protective functions SEBI performs following functions:

(i) It Checks Price Rigging:

Price rigging refers to manipulating the prices of securities with the main objective of inflating or

depressing the market price of securities. SEBI prohibits such practice because this can defraud

and cheat the investors.

(ii) It Prohibits Insider trading:

Insider is any person connected with the company such as directors, promoters etc. These

insiders have sensitive information which affects the prices of the securities. This information is

not available to people at large but the insiders get this privileged information by working inside

the company and if they use this information to make profit, then it is known as insider trading,

e.g., the directors of a company may know that company will issue Bonus shares to its

shareholders at the end of year and they purchase shares from market to make profit with bonus

issue. This is known as insider trading. SEBI keeps a strict check when insiders are buying

securities of the company and takes strict action on insider trading.

(iii) SEBI prohibits fraudulent and Unfair Trade Practices:

SEBI does not allow the companies to make misleading statements which are likely to induce the

sale or purchase of securities by any other person.

(iv) SEBI undertakes steps to educate investors so that they are able to evaluate the securities of

various companies and select the most profitable securities.

(v) SEBI promotes fair practices and code of conduct in security market by taking following

steps:

a) SEBI has issued guidelines to protect the interest of debenture-holders wherein

companies cannot change terms in midterm.

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b) SEBI is empowered to investigate cases of insider trading and has provisions for stiff fine

and imprisonment.

c) SEBI has stopped the practice of making preferential allotment of shares unrelated to

market prices.

2. Developmental Functions:

These functions are performed by the SEBI to promote and develop activities in stock exchange

and increase the business in stock exchange. Under developmental categories following

functions are performed by SEBI:

i. SEBI promotes training of intermediaries of the securities market.

ii. SEBI tries to promote activities of stock exchange by adopting flexible and adoptable

approach in following way:

a) SEBI has permitted internet trading through registered stock brokers.

b) SEBI has made underwriting optional to reduce the cost of issue.

c) Even initial public offer of primary market is permitted through stock exchange.

3. Regulatory Functions:

These functions are performed by SEBI to regulate the business in stock exchange. To regulate

the activities of stock exchange following functions are performed:

a) SEBI has framed rules and regulations and a code of conduct to regulate the

intermediaries such as merchant bankers, brokers, underwriters, etc.

b) These intermediaries have been brought under the regulatory purview and private

placement has been made more restrictive.

c) SEBI registers and regulates the working of stock brokers, sub-brokers, share transfer

agents, trustees, merchant bankers and all those who are associated with stock exchange

in any manner.

d) SEBI registers and regulates the working of mutual funds etc.

e) SEBI regulates takeover of the companies.

f) SEBI conducts inquiries and audit of stock exchanges.

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The Organisational Structure of SEBI:

1. SEBI is working as a corporate sector.

2. Its activities are divided into five departments. Each department is headed by an executive

director.

3. The head office of SEBI is in Mumbai and it has branch office in Kolkata, Chennai and

Delhi.

4. SEBI has formed two advisory committees to deal with primary and secondary markets.

5. These committees consist of market players, investors associations and eminent persons.

Objectives of the two Committees are:

1. To advise SEBI to regulate intermediaries.

2. To advise SEBI on issue of securities in primary market.

3. To advise SEBI on disclosure requirements of companies.

4. To advise for changes in legal framework and to make stock exchange more transparent.

5. To advise on matters related to regulation and development of secondary stock exchange.

These committees can only advise SEBI but they cannot force SEBI to take action on their

advice.

Role of SEBI in Curbing Ponzi schemes

The biggest fear that constantly lingers in the mind of investors is the expose to financial fraud.

The designated ‘Watchdog’ of Securities Market in India, the Securities Exchange Board of

India has failed many a times to protect the interest of investors. New measures are implemented

after the revelation of financial scandal’s but fraudsters seems to be one step ahead in this cat and

mice game. This scandal that took place recently is considered to be the most highlighted scandal

in the recent memory. This incident raised question mark on the functioning of SEBI as it

intervened too late in protecting the interest of the investors. The incident is marked as a failure

of SEBI in discharging its functions as the collective investment schemes were run in the name

of chit funds which indicated the grave failure of the state machinery that are considered to be

the regulators of the chit funds as per the law of the country.

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Depositories Act, 1996, SEBI pursues two streams of enforcement actions i.e.

* Administrative/Civil

* Criminal actions

Civil actions are those which include issuing directions such as remedial orders, cease and desist

orders, suspension or cancellation of certificate of registration and imposition of monetary

penalty under the respective statutes and action pursued or defended in a court of law/tribunal.

Criminal action involves initiating prosecution proceedings against violators by filing complaint

before a criminal court.

Consent Orders:

Consent Order means an order that settles administrative or civil proceedings between the

regulator and a person (Party) who may prima facie be found to have violated securities laws. It

may settle all issues or reserve an issue or claim, but it must precisely state what issues or claims

are being reserved. A Consent Order may or may not include a determination that a violation has

occurred.

The concept of consent orders has been derived from the success of the US Securities and

Exchange Commission (USSEC) in resolving the dispute among different entities. USSEC

settles over 90% of administrative / civil cases by way of consent orders. It can also slap

penalties on defaulters without taking recourse to long drawn litigation in courts.

Objective:

The main objective of these consent orders is to reduce the regulatory costs which can further

help in saving time and effort of Securities Exchange Board of India, which was earlier

consumed to pursue enforcement actions.

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Another main objective of consent orders is to provide flexibility of wider array of enforcement

actions to achieve the twin goals of an appropriate sanction and deterance without resorting to a

long drawn litigation before SEBI / Tribunal / Courts.

Procedure (where adjudication proceedings are pending):

1. If the party against whom an adjudication proceeding is pending proposes passing of a

consent order, the proposal may be referred to a high powered Committee consisting of a

retired judge of a High Court and two other external experts.

2. The Committee will consider the proposal of consent, requisite waivers by the party, the

facts and circumstances of the case, material available on records and take into account

the factors and guidance. Where the Committee finds the terms for passing a consent

order inadequate, it may ask the party to revise the consent terms.

3. The consent terms finalized by the Committee and agreed to by the party shall be

forwarded to the Adjudication Officer for passing a suitable order in line with the consent

terms.

Procedure (in other cases):

1. Any person (party) who is notified or who has reasonable grounds to believe that a civil/

administrative proceeding may or will be instituted against him/her, or any party to a

proceeding already instituted, may, at any time, propose in writing along with requisite

waivers for an offer of consent.

2. Any person (party) who is notified or who has reasonable ground to believe that a

criminal proceeding may or will be instituted against it, may, before filing a criminal

complaint by SEBI before any criminal court, propose in writing along with requisite

waivers for consent.

3. The Committee will consider the proposal of consent, requisite waivers by the party, the

facts and circumstances of the case, material available on record and take into account the

factors and guidance. Where the Committee finds the terms for passing a consent order

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inadequate, it may ask the party to revise the consent terms. If the Committee agrees with

the proposal, suitable consent terms shall be recommended to a panel of two Whole Time

Members, who may pass a suitable order in view of the recommendation of the

Committee.

Enforceability:

• The consent order shall be binding on the party and in cases where the party

undertakes any compliances, it has to comply with the same.

• If the party fails to comply with the consent orders it may lead to the following:-

Invite appropriate action under the respective statute against the party, Revival of the pending

administrative / civil action.

Compounding Of Offences:

Compounding of offences is a process whereby an accused pays compounding charges in lien of

undergoing consequences of prosecution.

Section 24A of the SEBI Act, 1992 permits compounding of offences by the court where

prosecution proceedings are pending. Compounding of Offence can take place after filing

criminal complaint with SEBI. It can cover appropriate prosecution cases filed by SEBI before

criminal courts. Any person who is notified that a proceeding will be initiated against him or any

party to a proceeding already initiated/ instituted can propose in writing for the settlement.

Objective:

The main objective of compounding of offences is to avoid the difficult and lengthy process of

criminal prosecution and further save time, cost and mental agony.

Consequences of non-acceptance:

• If HPAC rejects the proposal, the person making the offer shall be notified of the

same and the offer of settlement shall be deemed to be withdrawn.

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• The rejected offer shall not constitute a part of the record in any proceeding

against the person making the offer, provided, however, that rejection of an offer

of settlement does not affect the continued validity of waivers.

• SEBI and the party will be free to resort to legal recourse as may be available to

them under law and neither SEBI nor the Party would be entitled to use any

information relating to the settlement process in such proceedings.

• Any proceeding which had been kept in abeyance pending the consent process

will begin from the stage at which it was kept in abeyance.

Settlement before Securities Appellate Tribunal / Courts:

Where a matter is pending before SAT/Court, the same consent process will be undertaken and

the draft consent terms recommended by the Committee and approved by the panel of two

Whole Time Members will be filed before the SAT / Court. The SAT/Court may if found fit,

pass an order in terms of the consent terms and subject to such further terms as the SAT/Court

may find appropriate in the facts and circumstances of the case.

Factors to be considered for consent:

While considering the proposal of consent from any party, the Committee shall have due regard

to the objective of the respective statute, the interests of investors and securities market and

factors including but not limited to the following, where-ever applicable:

i. Intentional violation of rules.

ii. Party’s conduct in the investigation and disclosure of full facts.

iii. Presence of Gravity of charge (fraud, market manipulation or insider trading).

iv. History of non-compliance of the violator.

v. Whether there were circumstances beyond the control of the party.

vi. Violation is technical and/or minor in nature and whether violation warrants penalty.

vii. Consideration of the amount of investors’ harm or party’s gain.

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viii. Processes which have been introduced since the violation to minimize future violations /

lapses.

ix. Compliance schedule proposed by the party.

x. Economic benefits accruing to a party from delayed or avoided compliance.

xi. Conditions necessary to deter future non-compliance by the same or another party.

xii. Satisfaction of claim of investors regarding payment of money due to them or delivery of

securities to them.

xiii. Compliance of the civil enforcement action by the accused.

xiv. Party has undergone any other regulatory enforcement action for same violation.

xv. Any other factors necessary in the facts and circumstances of the case

Case Study:

Name of Party: Mr. Shantanu Prakash,

Promoter & Director of Educomp Solutions Ltd

Date: 7 June, 2011

Rule Violated: Regulation 13(4) read with 13 (5) of the SEBI (Prohibition of Insider

Trading) Regulations 1992(“Insider Trading Regulations”).

Facts: Mr. Prakash transferred 50,000 shares of Educomp Solutions Ltd to his wife, but

failed to make disclosures to the company as required by Insider Trading Regulations

following which, adjudication proceedings were initiated against him. Mr. Prakash paid

an amount of Rs.3,00,000 towards settlement charges.

Decision: The proceedings were disposed off.

Conditions for the Decision:

• Passing of this order is without prejudice to the right of SEBI to take enforcement

actions including commencing / reopening of the pending proceedings against the

Noticee, if SEBI finds that:

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a) Any representations made by the noticee in the consent proceedings are subsequently

discovered to be untrue.

b) The Noticee has breached any of the clauses/conditions of the undertakings/waivers filed

during the current consent proceedings.

Conclusion

Investment is considered crucial for the development of the capital market. Investment is the

indicator of economy level of the country. It is vital to protect the interest of the investors so that

they can be encouraged to make more investments. SEBI was established with the purpose of

regulating the capital market and protecting the interest of the investors. Several regulations are

made by the board for ensuring efficient functioning of the market. It would not be justified if the

effort made by SEBI in improving its position as a regulator of market is not appreciated. It is

extra ordinarily difficult for the market regulators to keep a check on each activities of the

financial market and prevent the scams that take place. But, SEBI by revising its regulations and

by making them more stringent and investors friendly has taken a commendable step. One of the

major steps taken by the government in improving the condition of the capital market and

protecting the interest of the investors was the amendment of the securities laws of the country.

This amendment was most awaited and we can expect from the board to act vigilantly and to

ensure that no such scams like Saradha and Sahara takes place in near future.

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SOLUTIONS TO NPA’s

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5.1 Steps which cure the disease of NPAs. “The issue of NPAs needs to be tackled at the level

of prevention rather than cure.”

Therefore, the steps that can prevent the piling up of NPAs are as follows:

1. CONSERVATISM:

Banks need to be more conservative in granting loans to sectors that have traditionally found to

be contributors in NPAs. Infrastructure sector is one such example. NPAs rise predominantly

because of long gestation period of the projects. Therefore, the infrastructure sector, instead of

getting loans from the banks can be funded fromInfrastructure Debt Funds (IDFs) or other

specialized funds for infrastructural development in the country.

2. IMPROVING PROCESSES:

The credit sanctioning process of banks needs to go much more beyond the traditional analysis

of financial statements and analyzing the history of promoters. For example, banks rely more on

the information given by credit bureaus. However, it is often noticed that several defaults by

some corporate are not registered in their credit history.

3. RELYING LESS ON RESTRUCTURING THE LOANS:

Instead of sitting and waiting for a loan to turn to a bad loan, and then restructure it, the banks

may officially start to work to recover such a loan. This will obviate the need to restructure a

loan and several issues associated with it. One estimate says that by 2013 there will be Rs 2

trillion worth of restructured loans.

4. EXPANDING AND DIVERSIFYING CONSUMER BASE BY INNOVATIVE

BUSINESS MODELS:

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Contrary to popular perceptions, the NPA in non-corporate sector is less than that in the

corporate sector. Hence, there is a need to reach out to people in remote areas lacking

connectivity and accessibility. More and more poor people in rural pockets should be brought

under the banking system by adopting new technologies and electronic means. Innovative

business models will play a crucial role here.

As said by the new M.D. of SBI, Mr. Viswanathan proposed ideas such as a single demat

account for all investments and credit cards for school students (above class 8th) to make them

aware with the banking system.

5.2 Bad loans have plagued the Indian banking sector, especially public sector banks. Net non

performing loans (NPLs) and restructured loans comprise 8 percent of total loans of Indian

banks. Also, the fact that several banks’ capital adequacy ratios are low, adds to pain. According

to the Reserve Bank of India (RBI) the total quantum of impaired assets stood at 9.8 percent of

loans, or Rs 5.5 trillion in absolute terms, at the end of FY2014. Troubled sectors such as power,

roads, steel and telecom account for 18 percent of the Indian banking system’s loans. About 49

percent of loans are restructured through the CDR process. Restructured loans saw high failure

rates in FY2013 and FY2014, which would suggest that NPLs are likely to rise over the next

one-two years. Banking stocks saw a huge hope rally on expectations speedy reforms by the new

government, however, the bad loan overhang still remains.

5.3 In present scenario NPAs are at the core of financial problem of the banks. Concrete efforts

have to be made to improve recovery performance. Measures required to be undertaken are

mainly two fold. Banks should make efforts first to avoid fresh addition on NPAs by their

effective presentation appraisal and secondly to recover the amount from accounts which have

already turned bad. Preventive Measures: Most of the bankers feel that genuine viability problem

of the borrowing units, weakness in credit appraisal system, absence of effective monitoring and

supervision of loan account, absence of credit information sharing among the banks etc. are some

of the significant causative factors of high level of NPAs internal to the banks.

So for preventive the fresh inflow of funds into the non-performing category, banks should

reformulate their credit appraisal techniques.

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Proper evaluation of the loan application may help in detecting the unviable projects at the first

instance.

Full information about unit, industry, its financial stake, management etc. should be collected.

Industrial cell should be established at the bank level, which would have complete information

about the industry and its prospects in future.

Proper credit monitoring should be equally emphasized. There should be proper flow of

information from the units regarding their financial area, annual accounts, stock reports etc.,

which would enable the banker to know the need based credit requirement of borrower and

warning signals for taking quick remedial action.

Banks should inspect the progress of the project or the business. Separate monitoring

department should be established in large branches for periodical review of accounts,

comparative risk analysis and compliance of terms and conditions of sanction. Equal emphasis

should be given for monitoring of standard assets also.

Banks should be equipped with latest credit risk management techniques to protect the bank

funds and minimize insolvency risks. Banks should develop credit derivatives markets to avoid

these risks. There should be regular outflow of senior bank officers from all public sector banks

for specialized training in training institute to equip them with latest procedures and practices.

Curative Measures: Besides making efforts to stop the fresh additions of NPAs banks have to

take steps to recover the amount from assets, which have already slipped into NPAs category.

Significant causative factors highlighted were slow recovery of legal cases, wilful default

induced by officially announced loan waiver schemes etc. the Indian legal system is sympathetic

towards the borrowers and works against the banks interest.

Despite most of their loans being backed by security, banks are unable to enforce their claims

on the collateral, when the loans turn non-performing and therefore loan recoveries have been

insignificant.

The Narshimham Committee on financial system (1991) has recommended the establishment

of Debt Recovery Tribunals (DRT) for the speedy recovery of the assets from NPAs category.

On the basis of recommendations 22 DRTs were established by passing the bill on Recovery of

Debt due to Banks and Financial Institutions Act 1993. But the performance of DTRs for the past

years has not been found satisfactory or up to the mark.

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The Act has some limitations, which must be removed to make its effective implementation.

At present one presiding officer is handling at least 80-90 cases per day. It is suggested that

DRT Act may be amended to enable the central government to appoint additional presiding

officers for speedy disposal of recovery cases.

One of the major factors accounting for delay in disposing of application by DRT is the delay

caused due to refusal by defendants to accept the summons, and at times due to change in

address too.

DRT may be empowered to order service of summons by hand, registered post and by

publications simultaneously. Attachment of immovable property of borrower is not admitted due

to service of summons.

Enforcement of security and obtaining court decree take unduly long time, it encourages wilful

default and ultimately the banks may be compelled to write off loans. Wilful default should be

declared a criminal offence.

Government should not go for mass waiver of interest/ instalments as it sends unhealthy signals

to the borrower. During 1990-91 there was a massive waiver of rural debt amounting to over Rs.

15000 crore and Rs. 65000 crore in 2008. These types of activities put a premium on wilful

default and dishonesty. It lowers the repayment ethics.

In case of government sponsored schemes government should assist in recovery. It may be

noted that suggestions enumerated will go a long way in reducing the NPAs. This will only

considerably improve the profitability of the banks, improve the quality of assets, but also make

the Indian "Banking system stringent, resilient and geared to meet the challenges of globalisation

(Mohan Kumar & Govind Singh, 2012).

5.4 The NPA picture of India’s government-owned banks have evolved so far:

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From Rs 53,917 crore, Indian banks gross non-performing assets (GNPAs) in September 2008

(just before the 2008 global financial crisis broke out following the collapse of Lehman

Brothers), the bad loans have now grown to Rs 3,41,641 crore in September 2015. In other

words, the total GNPAs of banks, as a percentage of the total loans, has grown from 2.11 per

cent to 5.08 percent.

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Surprisingly, in the pre-crisis period, private banks topped the list of banks with highest NPAs

(see the chart). A quick look at the top ten NPA scorers in September 2008 shows ICICI Bank at

the top.

This was followed by small and medium-sized private sector banks such as Karnataka Bank,

Lakshmi Vilas Bank, Kotak Mahindra and IndusInd Bank. Among the few sarkari banks that

figure in the list are Central Bank, Uco Bank and Syndicate Bank.

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By March 2009, a few months before the Congress-led UPA II assumed power, the scene began

changing gradually. More state-run banks began appearing in the picture. The country’s largest

lender by assets, State Bank of India (SBI) and Indian Overseas Bank found place in the list of

top NPA scorers. Still private sector lenders figured prominently in the list with ICICI and DCB

Bank leading the pack. To be sure, there is no direct link between the ascension of UPA-II and

the increase in the NPA picture, but this is when the state-run banks began feeling the heat of

NPAs.

Things had worsened to a great extent by March 2014, incidentally, months before the Narendra

Modi government assumed power at the Centre with a landslide victory over the Congress-led

UPA government. The bad loan troubles of government banks began to hit hard despite the best

efforts by banks to cover up possible NPA stock to restructured loan category. The list now is

dominated mostly by public sector banks, with eight out of ten banks being government owned.

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Twenty months into the Modi government rule, it wouldn’t be an exaggeration to say that state-

run banks are on the verge of a crisis due to their high NPAs, which constitute over 90 percent of

the total bad loans of the industry. Many of them have reported losses on account of huge NPAs

in the December quarter, surprising analysts. Investors are dumping shares of these banks while

there is a sense of uncertainty prevailing on the extent of troubles in the banking sector.

Nine out of 10 most stressed banks in the sector are government banks. The RBI has given a

deadline of March 2017 for all banks to clean up their balance sheets, which also require these

lenders to set aside huge chunk of capital in the form of provisions. RBI governor Raghuram

Rajan has given a clear message to banks to deal with the NPA problem upfront, instead of

postponing it and worsening it.

But, there is also huge capital implication on these banks on account of high NPAs too. Banks

need to set aside money (known as provisions) to cover their bad loans. The onus to keep

government banks stay afloat lies with the government, which is the owner of these banks that

control 70 per cent of the banking industry assets. Experts have opined that the government’s

promised capital infusion in these banks is inadequate.

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FINDINGS AND CONCLUSIONS

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6.1 Introduction

Banking in has transformed itself from a sluggish business to a dynamic industry since the

economic liberalization of the 1990s.The mighty PSBs dominated until 1990s and enjoyed strong

system support and the benefits of government ownership. They still hold 70% of the sector’s

assets. Private banks have focused on leaner retail banking operations, and are wilfully moving

away from the bank brand hub with more focus on the other channels like online banking mobile

banking etc. New private sector banks in the country are leading from the front with the nifty

technology and sophisticated management, while the PSB have well documented processes, with

multiple levels of controls and approvals, and are more branch-oriented. PSB has not

experienced the kind of losses that financial institutions of other countries have faced. Supported

by the strong economic growth of the past, prudent regulations, absence of complex financial

products and low defaulters ratio, the sector managed to withstand the global financial turmoil.

Indian banks have proved to be efficient users of capital and compare positively with the banking

sector in other emerging markets on metrics like profitability and NPAs.

6.2 NPA is those loans given by banks or financial institutions which borrowers default in

making payment of principal amount or interest.

When a bank is not able to recover the loan given or not getting regular interest on such loan, the

flow of funds in banking industry is affected. Also the earning capacity is adversely affected.

This has direct and immediate impact on bank profitability and efficiency. Under the prudential

norms, banks are not allowed to book any income from NPA. Also they have to make necessary

provisions for NPA which affects the profitability adversely. Lower profitability of banking

sector affects its growth and expansion. NPA is double edged sword. On one hand banks cannot

recognize interest income on NPA and on the other hand, it is a drain of bank’s profitability.

Moreover profits earned are required to be diverted for provision on NPA. The high level of

NPA is dangerous to the very existence of banks. Many banks in East Asian countries had to

close down due to high level of NPA.

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6.3 Since there is slow down in economy since last two years, credit off take has come down

significantly. While there is plenty of liquidity, the fear of NPA resulted in banks exhibiting a

definite reluctance to lend. Such situation has had an adverse effect on profitability as income by

way of interest on advances reduces, whereas due to excess liquidity in the system, interest

expenditure on deposits increases.

6.4 Public sector banks in India are covering nearly 85% of Indian banking. Inspite of various

private sector banks, and starting of new private sector banks, the PSBs are dominating as far as

banking business in India is concerned. The profitability and operational efficiency of each PSB

is different from that of others and most of them are having poor efficiency and profitability.

Organizational restructuring for improving governance of the banks and enhancement in

management involvement and efficiency. Financial restructuring refers to injecting capital by the

government with required and necessary conditions. Systemic restructuring provides for legal

changes and institutional building for supporting the restructuring process.

6.5 Major findings on the basis of the primary data and secondary data

PSB is the dominating player as it has maximum share in terms of the business. The

banks have incorporated the integrated risk management exception to this are some small

cooperative banks purely because of their size.

The banks and NBFC has incorporated the operational risk management as suggested by

RBI and Basel II. Inspite of the policies laid down by regulators for prevention of frauds

the banks are of the opinion that still the fraud persist by the borrowers.

NBFC focus on Collateral security and guarantee, with the result NBFC has least

percentage of NPA and all the banks and the financial institutions follow the

securitisation process which has been discussed in length in chapter 5 of this thesis. The

banks and the FI should consider these factors while accepting the collateral securities viz

Bank is of the opinion Credit card outstanding is one of the causes for NPA especially in

private sector. Private Banks issue credit card to weaker sections and students and

outstanding amount against these cards under these category is high.

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Educational loan is the least risk based since they are issued against the collateral

securities. Similarly the Finance Minister beside bar-coding the mark sheets the

suggestion put forward by the banks and financial institution include radio-frequency

identifications (REFID) for the loan availed or a notation in the degree certificates of the

borrower that would provide the loan details. This will enable the bank to plan their

repayment mode.

CIBIL enables to get information about defaulters but the small banks find it difficult to

enrol as a member because of high membership fees.

The banks prefer to lend loans to priority and agricultural sector as per the RBI norms

and maintain the percentage notified by the RBI. In order to minimise the agricultural

risk the banks and FI insist on insurance crops to the agricultural borrowers.

Political interference and political favouritism for sanctioning has been a cause strongly

supported by the private banks and disagreed by the Cooperative banks NBFC and public

sector were neutral in its approach. Delay in sanctioning as well as disbursement of loan

is one of the causes which was strongly agreed by Cooperative bank and disagreed by

private banks. These factors can be arrested by the Credit Monitoring Officer by

scrutinizing thoroughly all documents and rejecting if there is a default in fulfilling the

policy and procedures by the borrowers. Delay in sanctioning and disbursement of loans

is a cause of NPA.

A realistic and timely action or check would help the banks and borrowers to maintain

good functional relationship despite difference of opinion. However the bankers should

be firm in conveying their decisions which think are in the best interest of the borrowers

and bank at the earliest without wasting much of the borrower time. If these policies are

not followed there could be delay and fluctuation in the economic conditions may cause

imbalances and the entire act of the borrower and the bank may become futile. Failure to

perform this act can cause reduction in the profit of the banks.

Unstructured interviews were carried out with banks officials and it was found that some

banks give preference to community members. Management tries to help their

community without giving preference financial strength of the borrowers officer can

enable reduction strongly recommended by the Public Sector Bank and disagreed by the

Private Bank Compulsory credit audit is opined by the banks and NBFC except the

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private banks. According to PSB, private Banks and Cooperative Banks felt strict

appraisal shall be a source of reduction in NPA NBFC disagreed with this fact of

reduction. Complicated and delayed legal procedures are the cause of NPA.

Impact was high during first phase of reform period, subsequently the flow of credit to

priority sector reduced significantly. RBI passed a rule in their notification that priority

lending should be 40% out of which 18% shall be for agricultural advances 10% for SSI.

Since agricultural and weaker section did not get much attention there is a credit crunch

and which showed an impact in the beginning of post reform period. Agricultural

advances increased from 1999 to 2008. There has been a constant reduction in the

percentage of advance provided to the SSI. In 1999 the percentage of SSI advances

achieved was 17.3% were as in the year 2002 it dropped to 3.91% and in 2008 of

percentage was 10.9%.

The trend analysis shows that there is a fluctuation in the gross NPA of Scheduled Urban

Cooperative bank. In 1999 the level of gross NPA was 11.7% and subsequently in 2002 it

increased to 21.9% and in 2003 it reduced to 19% and again in 2004 it rose to 22.7% and

in 2005 it increased to 23.2%. This shows comparing to other sector of banks cooperative

bank has more NPA since they give preferences to priority and weaker section of the

borrowers.

Several Committees, Task Forces and Research Studies have identified the main causes

for the increasing of NPAs in priority sector advances of the banks. The banks face NPAs

due to external and internal factors. External factors are due to non viable activities in

rural areas. The internal factors are due to faulty assessment of the loan, ineffective

supervision and absence of timely action, etc. External factors are more dangerous than

internal factors. External factors are natural calamities, wrong selection of borrowers etc.

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The EY report explains quoting bankers, why banks and bankers don't declare borrowers as

wilful defaulters: "It is more or less certain that if we declare a borrower a "wilful defaulter," he

will approach the court. Then it becomes our responsibility to justify our action with supporting

evidence. It is not always possible to establish that the borrower has siphoned off the money or

used it for a purpose other than the one which loan has been taken. Hence, we need to be

extremely cautious before we declare someone a "wilful defaulter." Otherwise, we will not only

lose the case, but we will also let the defaulter off the hook."

As on December 31, 2014, the top 30 defaulters accounted for nearly one third of the bad loans

of close to $47.3 billion, which is clearly worrying. Also, many high value loans have gone bad.

And they keep piling up. In fact, in a survey carried out by the EY Fraud Investigation & Dispute

Services found that 87% of the respondents that included bankers stated that diversion of funds

to unrelated business through fraudulent means is one of the root causes for the NPA crisis.

Also, 64% of respondents believed that these bad loans resulted primarily because of lapses in

the due-diligence carried out by banks before the loans were sanctioned.

As the report points out: "Third party agencies such as surveyors, engineers, financial analysts,

and other verification agencies, etc., play a critical role in assuring financial information,

proposals, work completion status, application of funds, etc.

The trouble is that the system can and is being manipulated. "Reports are made as a routine, with

little scrutiny. In some situations, the reports may be drafted under the influence of unscrupulous

borrowers.”

For the entire process of loan disbursal as well as monitoring mechanism to work well, the third

party system needs to work in a transparent manner, which it currently doesn't. As per the EY

survey, two out of the three respondents agreed that third party reports could be manipulated in

the favour of the borrower. Further, 54% of the respondents attributed the bad loans to the

inefficiencies in the monitoring process, after the loan had been given out.

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And if all that wasn't enough 72% of the respondents claimed that the crisis in banking because

of bad loans is set to worsen before it becomes better. The reason for this is very simple-many

loans which have gone bad have not been recognised as bad, and instead have been restructured

i.e. the borrower has been allowed easier terms to repay the loan by increasing the tenure of the

loan or lowering the interest rate.

As the EY report said quoting the bankers who had participated in the survey: "The stressed

accounts that have been hidden till now would keep the NPA [non-performing asset] level rising

at least for the next 2-3 years." In simple English what this means is that many restructured loans

will turn bad in the years to come, as borrowers will default.

The EY report further pointed out: "The reported numbers are quite high, and there are fresh

additions every quarter, leading to further deterioration in asset quality. The portfolio of

restructured accounts is adding to the problem at hand, thereby resulting in crisis."

In fact, the corporate debt restructuring numbers have jumped up big time over the last few

years. The number of cases has jumped from 225 to 647 between 2008-09 and December 31,

2014. This is a jump of 187%. In fact, in terms of the amount of loans, the jump is 370%.

The bankers that EY survey spoke to made several interesting points. Several borrowers go

through the corporate debt restructuring mechanism just to ensure that they can drive down the

interest rates on their loans or increase the repayment period. Also, even in cases where the

borrower is in trouble nothing really comes out of the restructuring scheme. As the report points

out: "These schemes are often used to soften the pricing terms, elongation of repayments,

without improving the basic viability of the business."

Sebi set to get tougher with wilful defaulters: The Securities and Exchange Board of India

(Sebi) will make it difficult for so-called wilful defaulter from raising fresh equity or debt from

the public, according to two people familiar with the agenda of the regulator's next board

meeting. The move will mark yet another effort by the Indian government, the Reserve Bank of

India (RBI) and now Sebi to crack down on the problem of bad loans.'''

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RBI floats draft framework for account aggregator NBFCs: RBI has come out with a draft

regulatory framework for a new kind of Non-Banking Financial Company (NBFC) which would

act as an account aggregator to help people view their accounts across financial institutions in a

common format. Only companies registered with the RBI as NBFC - AA will be able to

undertake this business which will be IT driven. The proposal said an account aggregator will not

be able to undertake any other business.

Auto Biggies Speed up Make in India Drive: Three global automobile powerhouses either

have started operating their India factories round the clock or are in the process of doing so to

meet increasing export demand, in a resounding endorsement of the Prime Minister's call to

make in India. For the past six months, Ford Motor's manufacturing facility in Tamil Nadu is

running three shifts a day.

Services PMI cools to 3-month low :

Growth in India's services firms fell to a three-month low of 51.4 in February from 54.3 in

January, as output rose only marginally, according to a business survey. The seasonally adjusted

Nikkei/Markit Services Purchasing Managers' Index (PMI) had experienced a 19-month high

rate of growth in January, marking a seventh month above the 50-level that separates growth

from contraction.

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SUGGESTION & RECOMMENDATIONS

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7.1 The future picture of Commercial banks more so the banks & financial institution seem to be

brighter. Study suggests that the NPAs of banks & FI will decline marginally both in terms of

Gross and Net figures over next three years. This may be due to higher provisions, which the

banks have been providing. The real issues are percentage of NPA declining over the years but

the absolute figures seem to be increasing. A strong banking sector is important for a flourishing

economy. The failure of the banking sector may have an adverse impact on other sectors.

7.2 Credit to priority sectors have higher NPAs, due to increase in outstanding amount in priority

sector the banks face problems in further disbursement and increase their existing profits. Hence

managers of rural and semi-urban branches generally sanction these loans. In the changed

context of new prudential norms and emphasis on quality lending and profitability, managers

should make it amply clear to potential borrowers that banks resources are scarce and these are

meant to finance viable ventures so that these are repaid on time and relevant to other needy

borrowers for improving the economic lot of maximum number of households. Hence, selection

of right borrowers, viable economic activity, adequate finance and timely disbursement, correct

end use of funds and timely recovery of loans is absolutely necessary pre-conditions for

preventing or minimizing the incidence of new NPAs.

7.3 RBI should provide a Credit Code Number to each borrower & that should be quoted by the

borrower at the time of taking loans. Similarly these numbers should be exhibited in a separate

website which may be accessed by the banks or by the financial institutions. This will reduce the

multiple borrowings by the Individual borrower. At the time of opening an account he should be

asked to quote the Credit code number. This measure will reduce the multiple borrowing & with

the result the creditors can assess the creditability of the borrowers & his repayment capacity.

7.4 RBI should bring about a notification with respect to Guarantor his credit code number can

also be verified and the solvency state of the guarantor should be authenticated by the banker

were he maintains his savings account .RBI should set up a Flying Squad department to

introspect credit audit to be conducted by the credit auditors at random on a regular basis.

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7.5 Each auditor should be assigned a particular set of banks for a limited period & should be in

rotation, which shall reduce the favouritism & obligations from either side. The RBI should

maintain a site exclusively where a creditor gets detaild information along with his existing loan

and solvency state. Similarly RBI should maintain in its site Red, Amber and Green. It enables

the creditor to know that whether the borrower is a defaulter, or casual defaulter or a regular in

honouring his commitment.

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BIBLIOGRAPHY

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http://economictimes.indiatimes.com/markets/stocks/news/need2know-tackling-wilful-defaulters-a-roadmap-for-psu-banks-and-more/articleshow/51249516.cms

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