Banking General Awareness Banking System Challenges in Banking System

Challenges in Banking System

Our banking system, at present juncture, is facing significant challenges from several quarters. These challenges, if not addressed quickly and adequately, may result in loss of opportunities as and when the economic growth starts picking up momentum.

In a sense, it has implications for both- the banks as well as the economy as a whole, because a strong banking system is one of the essential pre-requisites in the quest for growth.

NON-PERFORMING ASSETS (NPAs)

A non-performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.

Description: Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.

1. Substandard assets: An Asset which has remained NPA for a period of less than or equal to 12 months.
2. Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
3. Loss assets: As per RBI, "Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value."

Bad loans now constitute 11 per cent of the gross advances of PSU banks, while total NPAs, including those for public and private banks, were Rs. 697,409 crore as of December 2016.

Presidential Ordinance on NPA

• The Presidential Ordinance empowered the Reserve Bank of India to enforce expeditious resolution of non-performing assets of banks.
• This initiative will boost legal empowerment of the central bank to crack down on NPAs of banks.
• The ordinance will have impact on the economy, the banking sector's lending behaviour and the country's investment climate.
• Union government has now empowered itself to direct the RBI to take necessary steps to initiate the NPA resolution process once a default has been established.
• It projects the role of the political establishment as a proactive agent in bank NPA resolution.
• It can also lead to a political risk because this will expose the government and the political establishment to charges of having used discretion to pick and choose the default cases requiring NPA resolution.
• The provisions of the Bankruptcy Code have now been linked to the Banking Regulation Act.
• It also allows the RBI to set up oversight committees for banks with NPAs.

Stressed Assets

Stressed accounts are the ones that show incipient signs of becoming NPA – like bounced cheques/ not submitting financial data/ stock shortages/ request for frequent overdrawal of account etc.

Stressed assets = NPAs + Restructured loans + Written off assets

Restructured assets or loans are those assets which got an extended repayment period, reduced interest rate, converting a part of the loan into equity, providing additional financing/ or some combination of these measures. Hence, under restructuring a bad loan is modified as a new loan. But the real problem is that it was actually an NPA.

Hence, the restructured loan is also a weak loan. NFAs and restructured loans together show the low asset quality of banks. These together are hence called stressed assets.

Written off assets are those that the bank or lender doesn't count the borrower owes to it. The financial statement of the bank will indicate that the written off loans are compensated through some other way. It doesn't mean that the borrower is pardoned or got exempted from payment.

CAPITAL ADEQUACY OF BANKS

Concerns have been raised about the ability of our banks to raise additional capital to support their business. Higher level of capital adequacy is needed due to higher provisioning requirements resulting from deterioration in asset quality, kicking in of the Basel III Capital norms, capital required to cover additional risk areas under the risk based supervision framework as also to sustain and meet the impending growth in credit demand/ going forward.

Capital Adequacy Ratio (CAR) is the ratio of a bank's capital in relation to its risk weighted assets and current liabilities. It is decided by central banks and bank regulators to prevent commercial banks from taking excess leverage and becoming insolvent in the process.

Capital Adequacy Ratio = (Tier I + Tier II + Tier III (Capital funds)) /Risk weighted assets

Tier-I Capital consists of:

Paid-Up Capital

Statutory Reserves

Other Disclosed Free Reserves: Reserves which are not kept aside for meeting any specific liability

Capital Reserves: Surplus generated from sale of Capital Assets

Tier-II Capital consists of:

Undisclosed Reserves and Paid-Up Capital Perpetual Preference Shares

Revaluation Reserves (at discount of 55%) Hybrid (Debt / Equity) Capital

Subordinated Debt

General Provisions and Loss Reserves

The risk weighted assets take into account credit risk/ market risk and operational risk.

The Basel III norms stipulated a capital to risk weighted assets of 8%. However, as per RBI norms, Indian scheduled commercial banks are required to maintain a CAR of 9% while Indian public sector banks are emphasized to maintain a CAR of 12%.

BALANCE SHEET MANAGEMENT

As a part of balance sheet management exercise/ the Board/Top Management would have to proactively take a call on the likely components of their balance sheets and what shape they would like the balance sheet to take in future. The objective of optimal utilization of capital would have to be necessarily kept in mind while evolving balance sheet management strategies.

Balance Sheet is the financial statement of a company which includes assets, liabilities, equity capital, total debt, etc. at a point in time. Balance sheet includes assets on one side, and liabilities on the other. For the balance sheet to reflect the true picture, both heads (liabilities & assets) should tally (Assets = Liabilities + Equity).

UNHEDGED FOREX EXPOSURES

Indian Companies have borrowed heavily in dollars, which can add to the stressed assets as these borrowings are unhedged in the forex market. This stress, besides impacting repayment of forex liabilities, eventually hampers their debt repayment capability to the domestic lenders as well. It is precisely with this consideration that RBI has been advocating a curb on the increasing tendency of the corporates to dollarize their debts without adequate risk mitigation.

RBI's S4A debt restructuring norms

The Reserve Bank of India (RBI) announced a scheme for Sustainable Structuring of Stressed Assets (S4A) for resolution of bad loans of large projects. This development would not only strengthen the lenders’ ability to deal with stressed assets, but would also put real assets back on track, benefitting both banks and the promoters of troubled entities. Under the scheme, a portion of the debt will be converted into equity or other instruments under the supervision of Indian Banks' Association's (IBA) overseeing committee, prescribed by the regulator.

Corporate Debt Restructuring

It is the reorganization of a company's outstanding obligations/   debts, often achieved by reducing the burden of the debts on the company by decreasing the interest rates and/or increasing the time to repay.

This allows a company to increase its ability to meet the obligations. Unlike Corporate Debt Restructuring (CDR), S4A does not allow the banks to offer any moratorium on debt repayment; they are also not allowed to extend the repayment schedule or reduce the interest rate.

Strategic Debt Restructuring (SDR)

Under SDR, banks which have given loans to a corporate borrower has the right to convert the full or part of their loans into equity shares in the loan taken company. The Scheme has been enacted with a view to revive stressed companies and provide lending institutions a tool to initiate change of management in companies which fail to achieve the milestones under Corporate Debt Restructuring (CDR). Here existing promoters are discontinued to hold majority stake in distressed companies. Under the S4A Scheme, banks would have to allow existing promoter to continue in the management even while being a minority shareholder; whereas in case of SDR, the promoter is delinked and ownership is changed.

5/25 Norm of RBI

The lenders are allowed to fix longer amortization period for loans to projects in the infrastructure and core industries sector, for say 25 years, based on the economic life or concession period of the project, with periodic refinancing, say every 5 years. This Norm does allow banks to convert the unviable portion of the debt into equity.

Asset Reconstruction Companies

An Asset Reconstruction Company (ARC) is a company that reconstructs or re-packages assets to make them more saleable. The assets in question here are loans from banks, card companies, financial institutions etc.

Debt Recovery Tribunals (DRTs)

Narasimham Committee Report I (1991) recommended the setting up of Special Tribunals to reduce the time required for settling cases. The Debts Recovery Tribunals have been established by the Government of India under an Act of Parliament (Act 51 of 1993) for expeditious adjudication and recovery of debts due to banks and financial institutions.

Debts Recovery Tribunal is the appellate authority for appeals filed against the proceedings initiated by secured creditors under Sub-Section (4) of Section 13 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002.