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Proposed Study and Report on
INDIAN BANKING SYSTEM
AND
NON-PERFROMING ASSETS
Organized by:
International Management Institute, Bhubaneswar.
Presented by:
Biswadeep Ghosh. Shankey Gupta
PGDM 2017-19 PGDM 2017-19
Roll.no: 18. Roll.no: 51.

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PREFACE
This paper on “Indian Banking system and NPA’s” is a collective effort of many intellectual
minds, which have either contributed either directly or indirectly to put the entire staggered
and diversified topic in a phased and précised manner, which will help the readers get to
know the basics of NPA’s in an economy and how a collaborative and comprehensive study
is needed to get into the depth of such matters. We would also like to express our gratitude to
our institute “INTERNATIONAL MANAGEMENT INSTITUTE, Bhubaneswar”, which
acted as a stage for us to display our content and made it available for vision and correction
by other sharp minds. We would also like to thank our faculty Mr. Shantanu Das and Mr.
R.K Panigrahi for sharing with us their insights and encouraged us to present this paper.

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Table of Content
1.Indian financial system and structure: 04.
2.Indian Banking system: 05.
3.Central bank of India & its function: 07.
4.Credit and monetary policy: 10.
5.Priority sector lending: 13.
6.Introduction to NPA’s: 13.
7.Causes and Impact of NPA’s: 19.
8.Acts & Schemes: 21.
9.Remedies & Measures: 22.
10. Conclusion: 24.

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Indian Financial system and structure
Introduction:
The market of an economy where funds are transacted between fund-surplus and fund-scarce
individual is known as a financial market. The financial system allows the exchange of funds
between lenders, investors and borrowers. The basis of all the transaction that occurs in a
financial market is either dividend or earning interests.
The financial markets have two categories, i.e. organized segments and unorganized
segments.
Further the financial market in any economy are further classified into two segments,
depending upon whether to cater the requirements of Short term funds and long term funds.
The short term financial markets are known as Money Market, whereas the long term
financial market is known as Capital Market.
Money Market: Money market is defined as the market where the short-term lending
and borrowing takes place between cash-surplus and cash-scarce parties. In money market
financial assets which have quick conversion quality into money and have a minimum
transaction cost associated are traded. The short period is defined for 365 days.
The crucial role of money market in any economy can be understood by the fact that if only
few lakhs or crores of rupees of working capital is not met in time, it can push an
organization or a firm to go for a lockout. If lockout happens, the firm or the organization
may default in its payment and may resulting in loosing credit worthiness.
Capital Market: The long-term financial market in an economy is known as Capital
market. In capital market, long term borrowing and lending activities are carried out, which
normally exceeds the period of 365 day. This market makes it possible to raise long-term
money (capital). Across the world, banks emerged as the first and the foremost segments in
the capital market. Mutual funds and security and stock markets also forms the part of
Capital market.

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# Structure of Indian Financial System#
Indian Banking System:
Banking can be defined as a business activity and operation of accepting and safeguarding
the money owned by an individual, a society or an organization and then lending out this
money to earn profit.
Banking industry forms an important part of an economy and it has its direct as well as
indirect implication on the various economic activities. Each country has its own banking
rules and regulation, which is subjected to various parameters, set by the government
authorities. Banking industry serves as an intermediary in the money as well as capital
market, where funds, capital, bonds and other financial tools are exchanged, purchased,
traded. The banking structure of any nation is guided by the rules and regulation framed by
its central bank, which governs, all the banking activities, has a look on various rates,
controls it, checks the implication of change in a particular rate in other parameters.
For example the central bank of USA is Federal Reserve; central bank of China is People’s
bank of China, for Germany its European Central Bank and when it comes to India, it is
Reserve Bank of India (RBI).
 Why an economy or a nation needs a Banking System?
The demand for money within an economy is determined by the price level and the level of
activity within an economy. Interest rates actively serve the costs of the money and the
corresponding rates are determined by the demand for the money. When demand falls, due
to decline in economic activities, interest rates also fall.

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When demand for money increases, interest rates also increases. Thus a strong and robust
banking system can provide an economy a guided flow of money among the various sectors
and segments and maintains a close watch between excessiveness and scarcity.
By attracting savings and granting credits, banks acts as a lubricant for an economy which
keeps it moving. Without banking system it would have been very difficult to identify who
wants to borrow money and who wants to save their money.
In any case, by chance a borrower defaults, bank serves as cushion for savers, they absorbs
loses by their own capital.
Banking system eliminated the torture, exploitation and harassment faced by the borrowers
from their prime lenders in unorganized sectors. It largely eliminates the fraud and
counterfeiting occurs at unorganized sectors.
Strong banking system can enables strong corporate atmosphere, because it is not possible
from the unorganized sector to get long term loans.
Central Bank of India: Reserve Bank of India
The Reserve Bank of India was set up in the year 1935, under RBI act 1934, as private bank
with primarily two main functions i.e. regulation and control of banks in India. RBI acts as a
banker to the government as well as other banks. The license approved by the RBI is quiet
necessary to perform the banking operations.
It regulates the currency notes and keeping the close watch on the reserves in a view to
securing monetary stability in India and generally to operate the credit and the currency
system of the country to its advantage. It also involved in managing statutory reserves and
debt management of the government.
The RBI puts a close watch and actively manages the time-quantity domain of the currency
flow within the economy, i.e. what is the right time and what is the right amount of currency
should be pumped into an economy at any point of time. The central bank not only supplies
money into the system but also determines the price of the money through variety of
mechanisms.
RBI act of 1934:
 Establishment of RBI.
 Contains the definition of scheduled banks.
 Section-18 deals with the emergency loans to the banks.
 Section-21 states that RBI can conduct banking affairs for central government and
manage public debts.

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 Section-22 states only RBI has the sole rights to issue currency notes in India, except
that of Re.1/-.
 Section-24, maximum denomination of notes that can be printed is of Rs.10000.
Banking regulation act, 1949 :
 Regulates all banking firms in India.
 Made it applicable to cooperative banks (since 1965).
 Empowered RBI to give license to banks, have regulations over shareholdings and
voting rights of shareholders.
Since RBI has the full autonomy to print currency notes and pumps it into the system, so:
Why the quantity of circulating money matters so much?
The quantity of money circulating in an economy affects both microeconomic and
macroeconomic parameters.
 At microeconomic level: A large supply of free and easy money leads to more
personal expenses. Individuals will have an easier time to get their loans sanctioned,
without having any accountability. Purchasing power will increase in contrast to the
resource availability.
 At macroeconomic level: An uncontrolled supply of money affects the many
important economic parameters such as GDP, overall growth, interest rates and
unemployment rates.
 The demand for money and interest rates varies inversely.
 Monetary inflation happens when the amount of money in circulation increases faster
than the goods in circulation, but if both the circulations are not handled properly, it
would lead to price inflation.

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Functions of RBI:
1. Print money: In Indian context, the RBI has the sole right and empowered to print
currency notes.
2. Set the reserve requirement: RBI mandates all other commercial banks to maintain
the certain percentage of their total funds as a reserve i.e. this is the amount of
money that will never enters the circulation. If banks have more accumulated
reserves, then it will try to bring it down by providing cheap loans.
3. Influence interest rates: Central banks also actively monitor the interest rates and
devise mechanism to push the interest rates towards desired level, i.e. if banks
borrow interest rates from the central bank at a lower rate; they need to pass the
benefit to the customers by reducing the cost of loans.
4. Stabilizes the foreign exchange rates: Central banks take part in the foreign
exchange markets, and carry out transaction to ensure exchange rate stability of
their own currency.
5. The central bank acts as an agent of the government in IMF.
6. Engage in open market operation: The RBI create money and use it to buy up
assets and securities such as government bonds.
7. Central bank manipulates and manages liquidity into the financial system.

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Credit and monetary policy: While the fiscal policy is conducted by the
government of a nation, the monetary policy is handled by the central bank of the nation. It is
the policy by which the desired level of money flown into and economy and its demand is
controlled and regulated, and based on the analysis government of a country achieves
macroeconomic targets like inflation, consumption, growth and liquidity.
Increasing money supply and reducing interest rates indicate an expansionary policy. The
reverse of this is a contractionary monetary policy.
RBI frames the monetary policy based on several tools known to them, such as open market
operation, repo rates, reverse repo rates etc.
Various tools of monetary policy are discussed below:
I. Open market operation: These include both outright purchase and sale of government
securities, to and from the market for injection and absorption of durable liquidity
respectively.
II. Cash reserve ratio: It is the certain percentage of cash deposits/bank deposits, which
banks are required to keep with RBI in form of reserves and balances. Higher the CRR
with the RBI lower will be the cash liquidity in the system.
 RBI uses CRR as a tool to drain out excess of liquid money from the system.
III. Repo rate: It is the rate at which banks borrows money from RBI by selling their
surplus government securities to RBI. RBI provides funds to the banks, whenever they

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feel that bank are running short of the money to run their daily obligation. Higher repo
rates may slow down the growth of the economy.
IV. Reverse repo rates: It is the rate of interest offered by RBI, when banks deposit their
surplus funds with RBI. Banks earn interest on such funds. It is the rate at which RBI
takes money from commercial banks.
 Higher reverse repo rates can prompt data to deposits more in RBI to earn higher
interests. RBI used to drain liquidity by this.
V. Bank rates: The prescribed rate at which RBI charges its long term lending is known
as Bank rates. The clients who borrow through these routes are government of India,
financial institution, Cooperative banks and NBFC’s.
VI. Statutory liquidity ratio: Statutory liquidity ratio is the amount that banks have to
invest in certain percentage of their deposits in specified financial securities such as
cash, gold, government approved securities before providing credit to the customers.
 Importance of SLR:
a) With the help of SLR, RBI can ensure the solvency of commercial banks.
b) It also helpful in controlling the bank credit expansion. By charging SLR, RBI can
readily increase or decrease the Bank credit.
c) Through SLR, RBI compels commercial banks to invest in government securities like
government bonds.
d) Through SLR, money supply in the system can be controlled efficiently. SLR is used
to control inflation and propel growth.

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Priority Sector Lending: All Indian banks have to follow the compulsory target of
priority sector lending. It includes sectors like Agriculture, SME’s, Small scale industries,
micro credit, education loans and housing loans.
The PSL target must be met by all the banks operating in India. Indian banks need to lend the
40% to the priority sector every year of their total lending; where as foreign banks need to
fulfill 32% of the total PSL target.
Introduction to NPA’s:
 Debt Servicing: The money which any other individual or any corporate house takes
from banks as a loan to perform its respective operation; it is an obligation upon him

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to make use of that debt in a proper and appropriate manner, so that it becomes
profitable. This is known as Debt servicing.
 Now the question arises if any individual or corporate house is not doing debt
servicing, how one can pay money back to the banks along with interests.
The most important assets for a bank are its cash balance, i.e. the deposits made in it.
From those huge cashes banks conducts financial transactions, such as giving loans to
individuals, corporates, industries, governments with an expectation that they will earn
interests along with the repayment of the principal. Thus these loans act as assets for the
Banks.
When banks are unable to recover their loans from those whom it had lent, the
functioning or working of these assets stops. Thereby it had been named as “Non-
Performing Assets”.
 Reserve Bank of India, has mandated the guidelines for the classification of NPA’s,
These are as follows:
1. Sub-standard Assets: It is classified as NPA, if any recovery has not been made for
a period exceeding 18 months. If you have not received any money form the loan
for a continuous period of 90 days, it will fall under the category of Sub-standard
assets.
2. Doubtful Assets: Assets that have remained NPA for a period exceeding 18 months
period is a doubtful assets.
3. Loss Assets: These are the kinds of assets where the losses can be readily identified
by the banks concerned or by the internal or external auditor or even by the RBI.
NPA’s are further subdivided into two quantitative tools, these are:
I. Gross NPA’s: It is the combined sum of sub-standard assets, doubtful assets and
loss assets. It is the sum total of all loan assets that are classified as NPA as per
RBI mandated guidelines. It reflects the quality of loans made by the banks.
 Gross NPA’s ratio = Gross NPA’s/ Gross advances.
II. Net NPA’s: Net NPA’s shows or reflects the actual burden on the banks. Net NPAs
are those type of NPAs in which the bank has deducted the provision regarding
NPA’s. In India bank’s balance sheet contains huge amount of NPA’s and process
of recovery and write off loans is very time consuming, so banks make provisions
according to the guidelines of RBI. Net NPA is calculated as follows:
 Net NPA= (Gross NPA-provision)/(Gross advances-provision)

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
Basel- III: The Basel- III norms are completely based on Capital Adequacy Ratio (CAR).
Out of the total capital of the banks, it needs to keep certain amount as SLR and CRR, which
is all total is a public money, but banks also have to maintain CAR, which is the own money
of the banks. This norm ensures financial stability and common standard of banking
regulation across all geographies. India is complaint to Basel- III norms.
E.g. If bank has a total capital of 100 crores, and 12.5% is the CAR, then 12.5 crores of
bank’s total capital should be the bank’s own money, not taken from public.
Advances: An advance is a credit facility provided by the banks to its
customers. It differs from loans in the terms that loans are granted for the
longer period of time, but advances are granted for the short period of time.
Further the purposeof granting advances is to meet day to day obligation of a
business or a firm. Interests are charged on the amount withdrawn, not on the
amount sanctioned.
Gross advances=Standard advances + Gross NPA’s.
Provision: Banks generally set aside a proportionate amount of money from
the profit to compensate the probable future losses caused on lending of loans.
This is known as provision.
Provision is a kind of current liability and banks know it very well that they
need to bear it in future, but it cannot be determined with substantial
accuracy.

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RBI has mandated a minimum CAR of 9%.
Capital adequacyratio: It measures the banks risk of going insolvent from excessive
losses. CAR is also known as Capital to risk weighted asset ratio (CRAR). CAR can be
calculated as follows:
CAR= (Bank’s tier-1 capital + Bank’s tier-2 capital)/ Risk weighted Assets.
Bank’s tier-1 capital: It is the ordinary capital of the bank. It is that capital which can
absorb bank losses without forcing banks to suspend its trading. This capital is easily
available to cushion the losses suffered by the banks.
E.g.: Ordinary share capital of the bank.
Bank’s tier-2 capital: It is that amount of capital of the bank that can absorb losses if the
bank has to shut down.
Risk weightedAssets: Each time a loan amount is sanctioned, it is assigned with a
degree of riskiness associated to it. Higher the percentage, riskier the loan is.
 As per Basel- III, banks need to have a tier-3 capital also.

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Present Situation:
 In February 2016, RBI conducted an AssetQuality Review for public sector banks
and reported that the amount of NPA’s in the Indian banking sector soared to such
a high level that the lending capacity of many banks plunged at the lowest level.
Net income of the bank has also decreased.
 The global rating agency, Moody in its latest report of 2013 has downgraded Indian
banking system’s rating outlook from stable to negative.
 Gross NPA or bad loans of state owned lenders surged to 56.4% to Rs.614872
crores during 12 months period ended on December 2016.
 At least five banks have reported gross NPA ratio of over 15%. Indian overseas
banks have reported gross NPA ratio of 22.42% i.e. out of every 100 rupees that
has been lent by the banks, Rs. 22.42 is classified as bad loans.
 After the Asset Quality Review conducted by RBI, investors who had put their
money on Public sector banks, fleeing away, bringing the value of the shares at a
very low level.
 Higher cost, lower revenue and greater financing costs all have squeezed the
corporate cash flows, quickly leading to the problem of Debt servicing.

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 Sectors like Infrastructure, Iron and steel, mining, aviation and telecom holds 54%
of the total stressed advances of PSB’s as of June 2015.
 Return on Assets (ROA) for Public sector banks in India is negative for the past 2
years, which is much below the prescribed rate of 1.5%.
 Due to such an abysmal condition of ROA, investors are not willing to invest, thus
share value of banks are decreasing.
 Stress has reached the telecom sector as freebies given by the new market entrant
Reliance JIO, which has increased the competition prompting a major round of
price cuts for others.
Causes and Impact of NPA: In context to Indian Banking sector, there are several
issues that cater the problem of NPA’s in the banks:
1. Willful defaulters, frauds, mismanagement and misuse of funds.
2. Delay in completion of projects, for which loans were sanctioned.
3. Business failures.
4. Corruption at the authoritarian levels of PSBs.
5. Lack of proper pre-appraisal and follow-ups.
6. Political level back hand available for loans sanctions.
7. Lack of technological driven banking operations.
8. Lackadaisical approach adopted by banks for recovery and absence of stringent laws.
9. Compulsion lending to the Priority sectors.

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NPA’s is one of the indicators to assess the soundness of banking sectors. They adversely
impact banks by reducing their profits in form of interests and provisions, reducing their
lending capacity and making them more risk averse.
When banks realize that they can’t recover the loans, they need to write it off, which means
the loans which appears in the asset side of the balance sheet now is totally eliminated, i.e.
the total loan amount vanished from the economy.
Non-repayment of loans from the existing borrowers prevents banks from lending to new
borrowers. This slowdown the credit recycling and reduces the size of credit line.
It results in lowering of the deposit interest rates by the banks to recover the bank loss from
the depositors, on contrary, the lending rates are increased by the banks, that discourages
genuine borrowers from lending and slows down the money circulation within the economy.
Even the domestic business which is the identity of an economy cannot survive as it will
become difficult to get a loan for their performance.
NPA’s may result in negative balance of trade, large unemployment and social unrest.
Balance of trade= Country’s export-Country’s import.
For competitiveness in the global market Export must be greater than Import.
An increase in NPA pressurizes banks to increase its capital base so that it will be Basel-iii
complaint. Thus, a rise in NPA not only affects the banking sectors but to the overall
economy.
SARFAESI act: It can be termed as Securitization and Reconstruction of Financial
assets and Enforcement of security interest act. It allows Indian Banks and other financial
institution to auction residential and commercial properties to recover loans. The 1st asset
reconstruction company of India was set up under this law.
Apart from waiving of interests to recover the only principal amount of the loan, Banks also
address the problem by pitching to Asset Reconstruction Company.
Since India is a BASEL-iii complaint, so it will have an obligation to maintain the CAR, so
Indian banks mainly reduces the Risk weighted asset, in order to increase the CAR, by
selling their bad loans to ARC, just depict the clean image of the Bank.
Government shifts the burden of Bad loans from Banks to ARC’s, thus the account of bad
loans decreases.
What will happen if ARC’s are also not able to get the money back?

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Then government infuses more capital into the ARC’s to bring them back in life, which is
ultimately a tax payer’s money.
“Indradhanush 2.0”: The government plans to come out with a scheme named
“Indradhanush 2.0”, a comprehensive plan for the recapitalization of the PSB’s. It is being
done with a view to keep the banks remain solvent and make the fully comply with globally
stated CAR, Basel-iii accord.
The RBI had embarked on the AQR exercise from December 2015 and asked all the banks to
recognize some of its top defaulting accounts as NPA’s and make corresponding provisions
for them.
Under this Indradhanush scheme, announced in 2015, the government had announced to
infuse Rs.70000 crores in the state-run banks over a period of 4 years.
Insolvency and Bankruptcy code: The insolvency and bankruptcy code, 2016 is
the bankruptcy law of India, which seeks to consolidate the existing framework by creating a
single unified law for bankruptcy. The insolvency and Bankruptcy code recommends two
separate tribunals to supervise the insolvency process- the National company law tribunal
(NCLT) for companies and limited liability partnership firms, while a Debt recovery tribunal
(DRT) for individual and partnership.
Till now 67 cases were filed since the IBC came into effect in December 2016.

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Remedies/Measures for managing NPA’s:
The economic survey conducted by RBI in the session 2015-16 suggested 4R’s ways of
addressing the problem of ongoing NPA’s, these are mentioned as follows:
Reform, Recognition, Recapitalization and Resolution.
Few other measures that can be adopted by the banks to properly address the problem of
NPA’s are mentioned bellow:
i. Adopting the policy of Disinvestments, as government can reduce their stake in PSB’s
and transfers the management of these banks to more competent persons.
ii. Government needs to shift the focus from priority sector lending, and need to
mandate the rules accordingly, as this sector also equally responsible for NPA’s.
iii. RBI and government can also put a check on the expansion of the bank branches,
which puts an extra burden.
iv. A strong and robust legal framework and guidelines must be constituted for banks as
well as for clients.
v. Proper verification of documents as well as collateral should be done before
sanctioning loans.
vi. Timely watch on the performance of the borrowers must be done and to bring them in
the lines of Debt servicing.
vii. Government needs to have close watch and properly regulate the boom and the bust
periods of an economy.
viii. There should not be any political influence driving the mechanism of giving loans.
ix. Bank management must be asked to appoint new and efficient management team.
x. A centralized model for sanctioning and recovery of loans should be set up.
xi. Government should reinforce or strengthen the financial position of the stressed
companies and frame provisions for it to operate with a substantial profit.
Conclusion
As all we can observe that corrupt and inefficient banking system and their loan mechanism
bore the brunt on the economy by augmenting NPA’s in it. The bad loans generated in due
course of time often affects the allied activities of an economy and how is this NPA’s is a
concern for government officials, policy makers, economists and what makes a
comprehensive analysis of NPA’s vital. What are the factors that lead to the cumulative rise
in NPA’s and how come a government plays a vital role in this context? Now how can
government deal with loans in the stressed sectors which acts as a key component for NPA’s
rise due to their failure in debt servicing? The government has also adopted few measures
and implemented certain schemes to address this problem in a judicious manner.

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