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NPA Management
The Need To Balance Credit Quality
With Growth

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NPA Management. The Need To Balance Credit Quality With Growth

NPA Management

The Need To Balance Credit Quality With Growth

The Financial Crisis
The 2008 financial crisis was a turning point in the history of the financial world for many reasons, the most
important being the heightened awareness and concerns around asset quality. Every step of the lending
process, from customer verification, profile risk assessment to collateral valuation came under the scanner.
The analysis concluded that there exists a trade-off between asset growth and quality, and in the quest for
growth, quality had been compromised.

The India Story

Indian Banks today are in a phase of rapid growth, with a credit to deposit ratio of 75%1 and an average
annual credit growth of 15%2. Banks are faced with the challenging task of maintaining/increasing credit
off-take to fuel GDP growth, while also ensuring quality is not compromised. An obvious outcome of low asset
quality is the growth in Non-Performing Assets (NPAs). NPA growth needs to be supported with a higher
level of provisioning, which in turn has a direct impact on bottom-line. Banks see a definite drop in retained
earnings and are forced to raise more tier 1 capital to sustain the same level of credit disbursements.
Intuitively, this points to an inefficient utilization of resources with ratios like profit margin and RoE being
directly impacted.
Concerns around asset quality have been a focus area for the Indian regulator as well. The Reserve Bank of
India (RBI) has talked about systems to track and classify NPAs way back in 2008. The RBI Master circular
dated September 2012 details out the Prudential norms on Income Recognition & Asset Classification (IRAC)
and emphasizes on the need for an effective mechanism and granular level data monitoring for NPA. The
finance ministry also echoed this sentiment when it directed all Public Sector Unit Banks (PSU) to automate
calculation and monitoring of NPAs by September 2011, and later extended the deadline to March 2012. The
basic objective is to increase transparency and consistency in financial reporting while creating an effective
mechanism to monitor NPAs.
In early 2013, Moodys had downgraded the rating of the Indian Sovereign and Banking industry from
Stable to Negative. Key reasons for this were the rising NPA levels and quantum of restructured loans
both of which were considered, symptoms of deteriorating asset quality. Some other studies, also predicted
that NPA levels for Banks were expected to reach 4% by March 2013 and 4.4% by March 2014. Overall, the
current NPA status was grim and checks and balances to monitor asset quality and NPAs in particular were
the need of the hour.
The NPA data below shows trends across Indian Banks. While Gross NPA gives an overview of gross NPAs/
Gross advances, Net NPAs are calculated after taking into account the provisioning already in place. NPAs
peaked in 2008, post which there has been a gradual decline. However, for PSU Banks which have a greater
exposure to risky sectors like power and agriculture, an increasing trend can be observed. Private sector and
foreign Banks appear to have been fairly successful in controlling NPAs.
Gross Advances 3
2008

Gross
NPAs

Gross NPA %

Net Advances

Net NPAs

Net NPA%

25,079

564

2.3

24,770

247

2.3

30,009

314

1.1

2009

30,383

682

2010

35449

847

2.39

35013

391

1.12

2011

43511

979

2.5

43106

418

0.97

2012

51589

1423

3.1

50842

649

1.4

RBI - Statement 1: Commercial Banks at a glance - September 2012

YOY growth rate as on December 2012
3
RBI report on Trends & Progress of Banking in India 2011-12
1
2

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NPA Management. The Need To Balance Credit Quality With Growth

Gross NPA to Gross Advances %

Net NPA to Net Advances %

Foreign Banks

Public Sector Banks

New Private Sector Banks

Old Private Sector Banks

Old Private Sector Banks

New Private Sector Banks

Public Sector Banks

Foreign Banks
1.8

1.8
2.2
2.3
2.2
FY 2007-08

4.3

3.1

2.9
2.3
2.2

2.4
2
FY 2008-09

2.5

2.6

2.7

2.2
1.8
3.3

1.9
2.4

FY 2009-10 FY 2010-11

FY 2011-12

1.2
1
0.8
0.7

FY 2007-08

1.9

1.4
0.9

FY 2008-09

1.09
1
0.8

FY 2009-10

1.7
1.2
0.6
0.5

0.6
0.6
0.5

FY 2010-11

FY 2011-12

In this era of global connectivity and quick transmission of shocks, banks need to monitor asset quality
very closely to ensure smooth functioning and spot any aberrations. Banks today have started adopting
many predictive and preemptive strategies to improve asset quality to specifically minimize NPA levels. The
prerequisite for this is to monitor the entire asset life cycle very closely.

NPA Management
Predictive

Historical data to
model customer
behaviour

Preemptive

Early warning
signals
Restructuring /
Special Offers
when delinquent
to prempt NPAs

Predictive Analytics has been effectively used in some

cases to score customers, based on behavioral and
demographic /psychographic parameters. These
scores are considered to be a fairly accurate indicator
of expected repayment behavior and determine credit
eligibility. This can be used effectively to decide whether
or not an asset product is to be cross-sold to a customer
or to determine the terms. Credit Information Bureau
India Limiteds (CIBIL) scores, attempt to provide this
kind of data even at an inter-bank level.

Once assets are sold, preemptive analytics come

into play. Early warning signals are created that flag
off assets that are delinquent or tending towards
delinquency. This provides a head start to Banks that
then work with customers, to ensure they dont become full blown NPAs. In this manner, preemptive and
predictive analytics play a key role in the NPA management strategy of a bank.
Credit Scores
provided by Third
party

Analysts and experts today consider NPAs to be one of the key indicators determining the health of the
balance sheet along with other measures like CASA ratio and NIM. The regulatory guidelines, on the topic,
classify assets into 4 broad categories standard, substandard, doubtful and loss assets with progressively
increasing provisioning levels. There are also specific norms governing collateral apportionment, treatment of
restructured assets and complex credit facilities like syndicated loans.
NPA
Classification

Provisioning

Standard Asset
0.25% - 1% of
outstanding

Standard
<90 days

Substandard
90-365 Days

Sub Standard
Asset 15%

Doubtful

Loss

Doubtful
100% (unsecured) +
25% - 100% (secured)

Loss Assets
Write off / 100%
(outstanding)

Income
Recognition

Banks face many challenges on the path to achieve NPA automation and monitoring goals set by RBI. First
and foremost, is the presence of multiple source systems, housing data pertaining to different asset products/
facilities availed by the same customer. While, some of these systems may be equipped to automatically,
perform NPA calculations, others are not. RBI guidelines advice Banks to take a customer view rather than
a facility view, which implies that data from multiple systems needs to be integrated to provide a unified
NPA view at customer level. This is in tandem, with the cross default clause, that features in many loan
agreements and monitors repayment behavior. Default on one facility will have consequences on all the other
facilities granted to the customer by the same Bank.

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NPA Management. The Need To Balance Credit Quality With Growth

Secondly, the process of NPA computation needs to be automated to be able to handle different product
types and the huge data volumes. Additional layers of complexity are also introduced by the presence
of an underlying asset (collateral) whose value needs to be appropriately apportioned before calculating
provisioning levels. Automation promotes consistency and a relatively error-free calculation while potentially
reducing resource requirements for the activity.
Finally, once the key metrics pertaining to NPAs are calculated, they also need to be incorporated, in the
relevant financial statements. Additionally, a lot of analyses can also be performed at this stage to understand
process issues, discrepancies, which led to NPAs in the first place. The insights obtained at this stage,
would provide critical inputs, to the preemptive asset quality management strategies followed by Banks and
go a long way in managing the challenge of balancing growth with quality. Overall, a key feature, any Bank
will look for while automating NPA management is the flexibility to handle new product launches, new source
systems and external changes like modifications in regulatory guidelines. An asset management cycle is
depicted in the following diagram.
Automate NPA
Computation

Monitor
Early warning
flags

Handle a variety
of asset classes.
Provide unified
view of NPAs

Preparation

Provision
Built-in
accounting
interface

Processing

Meet Regulatory
Requirements

Multi-dimensional
Analyses

Regulatory
Reporting

Insights into
potential causes
for NPAs

Presentation

Preparation: This stage encompasses obtaining data from multiple source systems to ensure a single view
of each customer. The challenge is also to handle and process a variety of special cases like securitized
assets and syndicated loans. Early warning signals can also be configured at this stage on the basis of which
reports will be generated which list out cases that fall into the potential NPA category. This is detailed in an
earlier section of this paper as a typical preemptive step to ensure assets do not become NPAs.
Processing: NPAs are first classified into the appropriate buckets after considering a variety of factors like
vintage, product type, availability of collateral. Calculating provisioning levels requires collateral data also to
be integrated. Also, restructured loans have more stringent provisioning criteria which need to be taken into
consideration. There could also be some facilities which are exempt from NPA computation. Though NPA
calculation and provisioning is automated, Banks will still probably need to cross check the calculations. In
some cases, discretionary calls may also be taken to reclassify. At this stage, it is crucial ensure changes
are auditable and this requires having in place a review mechanism. An accounting interface would also be
needed, to seamlessly integrate the figures thus calculated, into the balance sheet, income statement and
other relevant financial statements.
Presentation: NPA and provisioning levels once calculated need to be reported. After meeting the obligatory
regulatory requirements, Banks will also typically like to study the NPA data along multiple dimensions like
product type, branch, geography and industry/sector and do a root cause analyses, to identify weak links in
the asset lifecycle.

Conclusion
Smart Management of the asset lifecycle can enable Banks to not just be compliant, but over the long term,
also help adjust their credit policy, product portfolio and lending processes in a bid to reduce bad loans.
From a regulatory perspective, NPA data helps in building an accurate picture of asset quality which in turn
becomes a useful input in macroeconomic policy making <

About the Author:

Shivani Venkatesh is a Lead Consultant at iCreate and comes with rich experience in Consumer
Banking (Channel Management, Proposition Development, Customer Portfolio Management and
Segment Strategy). Shivani is currently working with iCreates solutions team in building nextgen
banking decision enablement products and solutions.

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