1. BACKGROUND/OVERVIEW
“Borrow Rs.100 from a bank, it’s your problem. Borrow a hundred million it’s the banks problem”
Debt is classified as an NPA (Non-Performing Asset) when loan payments have not been made for a period of 90 days. It was RBI’s independent initiative to conduct a review of the NPA monitoring system during the second half of 2013 and what they found wasn’t impressive. It’s common knowledge that financial institutions overstretch lending in periods of economic upturns and restrain it during downturns. Same happened in India with the year 2009 acting as a dividing line between the boom and the bust. It’s because loans given during the period of booms are riskier than those given during busts. One of the main factors behind this is the increase in the valuation of collateral, which increases ability of economic agents not only to borrow but also sustain economic shocks. But resultantly valuation of this collateral tends to fall during bust. Hence asset price cycle tends to accompany credit cycle.
Collateral valuation is inversely related to NPA’s. Hence, when valuation is high during boom, NPA’s are less and when valuation is low during bust, NPA’s are high. It takes 6 years for NPA’s to start showing in the banks’ B/S.
From the early 2000’s to 2008 there was decline in the NPA’s ratio (credit growth rate 20%). But after 2008, first there was a marginal, and then a striking increase as seen in the Appendix (Credit growth rate dropped to single digit). PSBs (Public Sector Banks) were major drivers of system wide NPA ratio after 2008, with private sector joining in 2008 and after a revival again in 2011. As of June quarter 2017, while all private banks (including foreign banks) have posted profit, on the other hand, 9 of the 21 listed PSB’s made losses (between Rs133 – Rs853 Crores).Laden with Rs7.33 trillion bad loans, PSB’s have more than 88% share of the total bad loans of all listed banks, far higher than their share of banking assets. With private and foreign banks managing Rs 0.99trillion in bad loan.
2. OBJECTIVE
The objective of this paper is to focus on illegal and unethical practices in collateral management framework as one of the major factors in increasing NPA’s in India.
TABLE1. (Amount in Rs. Crores)
As we can see from the above table 1, banks only have a light cushion present in return for the vast amount lent.
An RBI Report shows that 5 sectors – mining, iron &steel, textiles, infrastructure and aviation together make 24.8% of loan advances by commercial banks but have a share of 51.1% in NPA’s. This happens due to the herd mentality of bankers, wrong borrower selection, accepting photo copies as collateral papers instead of original, documents are filled with futuristic company outlook instead of the present state, irregularities around collateral are present which include improper charge creation and unclear title deeds. It also includes the practice of selling immovable property which was already acting as a collateral against which the loan had been taken. Not obtaining adequate tangible collateral security at the time of enhancement in credit exposure has also been a challenge. In consortium banks depend on the largest lender to do the accounts
Kingfisher in 2006 obtained loan on its brand Valuation of Rs 3000 Crore (as calculated by Grant Thornton). Brand valuation is an intangible asset. It had even kept its B/S for collateral, though surprisingly in its short tenure it never became green from red. It already had a whopping Rs 5665 Crore debt when IDBI lended it further Rs. 900 Crore.
Basically the banks (especially PSBs) were focused on over valuing and ballooning their B/S instead of the asset quality. The commercial principles were not being looked upon.
Though the blame went on economic slowdown, many of the defaulters were willful defaulters (defaulted while even having the capacity to pay up or, diverted money for other purposes)
3. APPROACH AND METHODOLOGY
There are various steps which can be taken for better collateral management. Some of which are;
There should be an IT enabled, integrated collateral management framework and database which should help banks in not only monitoring the collateral on an ongoing basis but also detect incipient cases of fraud in time.
When loans are provided during boom, the collateral should be the weighted averaged to what its value would be during bust, so that the banks don’t lose money on faulty valuation. This prudent policy can help in the long run.
Banks should also conduct forensic audits before providing loans, rather than before taking the company to the Insolvency & Bankruptcy Board. Surprise visits of respective projects should be conducted. Concentration should not only be on the borrower but also on the group entity as a whole. EWS (Early warning signals) should not be seen as an additional task, but must be integrated with the credit monitoring process. Banks should enhance their skill set on credit assessment and evaluation of its employees. Instead of only the lead lender, all banks that are a part of the consortium should do the accounts of the company to which the loan is given.
Medium sized banks are not apt for providing such huge loans; instead only the large banks, huge financial institutions, insurance companies, should be utilized for providing huge sum of loans. External auditing teams should be selected so that there can be no influence from the corporate and the bank.
Companies can also provide loans to each other (not referring to investment). When a company would provide loan, it would do it with the due diligence and conduct forensic audits before providing the loan, and would be very particular about being returned its own personal funds.
Banks should not only focus on Corporate’s official documents but also on Market Intelligence.
APPENDIX
Hello there ! So I had written this for a Research Paper Competition organized by St.Stephens , but it didn’t get selected , so I felt that’s alright lets just upload it on the blog . Do share your views in the comments section! And I hope you enjoy reading it.
Bookaholic Meets Finance Aficionado 