Non-performing Assets or NPA is a big issue in front of financial institutes and banks. It is estimated that the total value of such assets was more than 10 Lakh Crores at the end of the financial year 2018. And the total commercial credits were 54 Lakh Crores. It is estimated that the undeclared or undisclosed Non Performing Assets in India were 3 Lakh Crores further. It was a huge amount. Ineffective NPA management is the main reason behind it.
Though it is an inherent thing to have credit risks in the banking business. Banks do the task of financial intermediation by undertaking asset liability transformation and size and maturity transformation. Also, risk transformations are done by banks to safeguard the business. The result of this transformation is that the banking business has become a risky business.
The risks are many. Banks have credit risks, market risks such as interest rate, liquidity, share prices, and foreign exchange risk, equity price risk, and so on. As far as operational and general risks are concerned, they are many. Non Performing Assets in India are not desirable, and they aid in the losses of financial companies.
Credit risk is a major source of NPA. Due to weak or poor risk management, banks give more credit risks. When the credit and risk management policies are not proper or ineffective, banks crystallize more NPA. Improper NPA management added to it further. This way, it is a vicious circle.
Global financial crisis shows the ineffectiveness of credit management
If we look at the global financial crisis, then the main contributor to it is NPA. And the main reason behind NPA is ineffective credit management policies. In India, it is more visible in the public sector banks because they have a large demand for loans. And due to the pressure of increasing business, they tend to make the credit and risk management policies lenient.
When there is a big economic expansion and growth, banks have to augment their capital through increased participation in the domestic as well as capital markets. Not just that, they have to retain earnings. When there is a recession period, banks find it further difficult to raise capital. It is because of the high cost of funds and lesser availability of capital funds.
Studies conducted on the NPA management of Public Sector Banks in India revealed that these banks followed quite liberal and loose credit policies. They had a high concentration of loans on specific borrowers or sectors. This resulted in huge exposure to a limited number of borrowers. For example, a few sectors like power, mining, steel, infrastructure, and telecom companies were big borrowers.
Since these banks could not manage their credit and risk policies firmly, they had more Non Performing Assets in India than their counterparts. It was also revealed that the management in these banks was not efficient and strong in their performance. Therefore, the NPA and NPA ratios were very much increased in these banks.
So, liberal credit policies and loose terms and conditions were the prime reasons. They were further supported by deficiencies in credit sanctions and loan disbursement.
Moreover, these banks were not effectively regulated by the Reserve Bank of India, the central regulating authority. There are no penalties or incentives for the performance of banks. Neither is there any mechanism to measure their accountabilities and responsibilities.
Strong measures are to be taken to make NPA management effective. To control this, PSBs need to develop the required skills across all levels. Their working mechanism, policies, and procedures need to be modified to bring more stringent NPA management possible. The regulatory procedures should also be made more specific. Only then can the situation with Non Performing Assets in India be controlled.