A STUDY ON “NON PERFORMING
ASSETS (NPAs) - WITH SPECIAL REFERENCE TO COMMERCIAL BANK OF
A Research Report submitted for the “Fourth International Conference on Ethiopian Economy – June 2006”
Submitted by:
R.DHANUSKODI
Lecturer,
Department of Accounting
Faculty of Business and Economics
Post Box 378
Phone: 0471 – 119380 (Residence)
Email ID: d_kodiudt@yahoo.co.in
dhanus_jothi@fastermail.com
21.04.2006
ABSTRACT
Banks play a very important role
in the economic development of every nation. They have control over a large
part of the supply of money in circulation. Banks are the main stimulus of the
economic progress of a country. In general there are several challenges
confronting of commercial banks. The main challenge confronting the commercial
bank is the disbursement of funds in quality assets (loans and advances), in
this paper; the researcher has attempted to study the Non-Performing Assets
(NPAs) in Commercial Bank of
Commercial Bank of
The present research work titled as “A study on Non-performing Assets- with special reference to CBE”. It has been divided in to six chapters.
The first chapter gives a bird’s eye view of the Meaning and definition of NPAs, NBE’s regulation to NPA, General reasons for assets becoming NPAs and General methods of Management of NPA.
The second chapter includes a brief description about the Statement of the Problem, Objectives of the study, Reasons for selecting CBE and Survey design of the study. The third chapter explains the problems of CBE regarding NPAs. The fourth chapter deals with Analysis; in this chapter the researcher has mentioned ten years loans and advances of CBE, Gross NPAs and details about impairment losses of CBES due to NPA.
The fifth chapter has been allocated for Summary of findings. The sixth chapter has been used to give Suggestions for solving the problems of NPA.
(i)
TABLE OF CONTENTS
Sl.No. Contents Page
No.
1 Abstract
i
2 Table of Contents ii
3 List of Tables
iii
4 List of charts iv
5. List of
Abbreviations v
6. Chapter: I
Introduction 1
7. Chapter: II
Methodology 7
8. Chapter: III Problems of CBE regarding NPA 8
9. Chapter: IV Analysis 10
10. Chapter: V Summary of
Findings 13
11. Chapter: VI
Suggestions for solving the Problem of
NPA. 14
12 References 16
(ii)
LIST OF TABLES
Sl.No. Table
No. Contents Page No.
1. 1.1 Details of Provisioning
Requirements for
Loans and
Advances 4
2. 3.1 Trend of Total Expenses 8
3. 3.2 Profitability of the Bank 9
4. 3.3 Return on Assets and Equity 10
5. 4.1 Year
wise details of Loans and Advances 11
6. 4.2 Year wise details of the NPAs in CBE 12
7. 4.3 Movement of Provision for
impairment losses 13
(iii)
LIST OF CHARTS
Sl.No. Chart No. Contents Page No.
1. 1.1 General methods Management of
NPAs 5
2. 3.1 Trend of Total Expenses 9
3. 4.1 Year wise Details of Loans
and Advances 11
(iv)
LIST OF ABBREVIATIONS
Serial Number Abbreviations Expansions
1 NPA Non-Performing
Asset
2. NPAs Non-Performing
Assets
3. NBE National
Bank of
4. NO. Number
5. SBB Supervision
of Banking Business
Directives
6. CBE Commercial
Bank of
7. Mn. Million
8. ROA Return
on Assets
9. ROE Return
on Equity
10. CAR Capital
Adequacy ratio
11. Sl. Serial
12. NPL Non-performing Loan
(v)
CHAPTER: I
1.1 INTRODUCTION:
“A Man without money is like a bird without wings”, the Rumanian proverb insists the importance of the money. A bank is an establishment, which deals with money. The basic functions of Commercial banks are the accepting of all kinds of deposits and lending of money. In general there are several challenges confronting the commercial banks in its day today operations. The main challenge facing the commercial banks is the disbursement of funds in quality assets (Loans and Advances) or other wise it leads to Non-performing assets.
1.2 NPAs –MEANING:
An asset which ceases to generate income of the bank is called non-performing asset. The past due amount remaining uncovered for the two quarter consequently the amount would be classified as NPA for the whole year. It includes borrowers’ defaults or delays in interest or principal repayment.
1.3 NBE’S DEFINITION OF NON-
PERFORMING:
NBE [Supervision of Banking Business Directives (Directive No. SBB/3212002)] defines, the term Non-performing is, “loans or advances whose credit quality has deteriorated such that full collection of principal and /or interest in accordance with the contractual repayment terms of the loan or advances is in question”.
1.3.1 For purposes of this Directive, loans or advances with pre-established repayment programs are non-performing when principal and or interest is due and uncollectible for 90 days or more beyond the scheduled payment date or maturity.
1.3.2 For purposes of this Directive, overdraft and loans or advances that do not have a pre established repayment program shall be considered as non-performing when;
- The debt remains outstanding for 90 consecutive days or more beyond the scheduled payment date or maturity.
- The debt exceeds the borrower’s approved limit for 90 consecutive days or more.
- Interest is due and uncollected for 90 days or more or
- For overdrafts, the account has been inactive for 90 consecutive days and / or deposits are insufficient to cover the interest capitalized during the period.
1.3.3 For purposes of this Directive, the entire principal balance of loans or advances outstanding exhibiting the characteristics described under 1.3.1 and 1.3.2 shall be considered as non- performing.
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1.4
NBE’S REGULATIONS TO NPA:
In order to ensure greater transparency in the borrower accounts and to reflects actual health of Banks in their balance sheets. NBE introduced regulations relating to NPA, the most important four aspects are as follows.
1.4.1 Suspended Interest Account:
It means an account where previously accrued but uncollected interest on loans or advances required placing on non- accrual status is reserved out of the income of the bank. A separate account opened in the name of Suspended interest Account, the uncollected interest amount transfer to this account.
1.4.2 Classification of Loans or Advances:
As per the NBE’s Directive, banks shall classify all loans and advances into the following five categories.
A. Pass:
Loans or advances in this category are fully protected by the current financial and paying capacity of the borrower and or not subject to critism. In general, any loans or advance or portion thereof, this is fully secured, both as to principal and interest, by cash or cash substitutes, shall be classified under this category regardless of past due status or other adverse credit factors.
B. Special mention:
Any loan or advance part due 30 (thirty) days or more, but less than 90 (ninety) days shall be classified Special Mention.
C. Substandard:
Non-performing loans or advances past due 90(ninety) days or more but less than 180(one-hundred- eighty days) days shall, at a minimum, is classified sub standard.
Without prejudice to the classification criteria used for
the sub standard category set out above, the following non-performing loans and
advances shall be categorized as substandard;
ii) Renegotiated non-performing overdraft facilities unless equivalent of all past due interest is paid by the borrower in cash at the time of renegotiation and the account shows at a minimum.
ØA nil balance at least once; or
ØA turnover rate of once the approved limit.
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iii) Renegotiated non-performing merchandise loans unless physical inventory of the merchandise taken by the bank at the time of renegotiation shows that the outstanding principal loan and interest thereof are fully covered and the safety margin determined, following the inventory is at least not lower than the margin stated in the loan contract entered into by the bank and the borrower at the time of initial extension of the loan.
D. Doubtful:
Non-performing loans or advances past due 180 days or more, but less than 360 days shall be classified, at a minimum, as doubtful.
E. Loss:
Non-performing loans or advances past due 360 days or more shall be classified as Loss.
1.4.3 Provisioning Requirement for Loans or Advances:
All Banks shall maintain a Provision for Loans Losses Account which shall be created by charges to provision expense in the income statement and shall be maintained at a level adequate to absorb potential losses in the loans or advances portfolio. In determining the adequacy of the Provisions for Loan Losses Account, provisions may be attributed to individual loans or advances or groups of loans or advances.
The provisions for Loan Losses Account shall always have a credit balance. Additions to or reductions of the Provisions for Loan Losses Account shall be made only through charges to provisions in the income statement.
Based on the asset classification, the banks are required to make a provision against the Loans or advances. Bank shall maintain the minimum provision percentages against the outstanding provision and of each loan or advances. The details of provisioning are given in the Table 1.1
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Table: 1.1
Details of Provisioning
Requirements for Loans and Advances
|
Sl.No. |
Classification of Loans and Advances |
Minimum Provisioning |
|
1 |
Pass (in accordance with the following build up in minimum required provisioning) uBy December 31, 2002 uBy June 30, 2003 uEffective January, 2004 |
0.5% 0.75% 1% |
|
2 |
Special Mention (In accordance with the following build up in minimum required provision) uBy December 31, 2002 uBy June 30, 2003 uEffective January, 2004 |
1% 2% 3% |
|
3 |
Sub-standard uUntil December 2003 uEffective January 2004 |
25% 20% |
|
4 |
Doubtful |
50% |
|
5 |
Loss |
100% |
Source: NBE’s Supervision of Banking Business Directives
In the case of loans secured physical collateral:
ÜUntil
of non-performing loan provided the estimated value of the collateral used for
this purpose shall not exceed 100% of the outstanding non-performing loan.
Ü Starting from 1 January 2004, net recoverable value.
1.4.4 Capital Adequacy:
NPA doesn’t earn any income, it adversely affects the capital adequacy ratio, and the adequacy ratio reveals the health condition of the bank. The capital adequacy ratio is defined as the ratio between a bank’s total capital and its risk-weighted assets.
1.5 GENERAL REASONS FOR ASSETS BECOMING NPAs
A multiplicity of factor is responsible forever increasing size of NPAs in banks. A few prominent reasons for assets becoming NPAs are as under.
--4--
4Poor credit appraisal system
4Lack of proper monitoring
4Reckless advances to achieve the budgetary targets.
4There is no or lack of corporate culture in the Bank. In adequate legal provisions on
foreclosure and bankruptcy.
4Change in economic policies/ environment.
4No transparent accounting policy and poor auditing practices.
4Lack of coordination between banks.
4Directed lending to certain sectors.
4Failure on the part of the promoters to bring their portion of equity from their own
source or public issue due to market turning lukewarm.
1.6 GENERAL METHODS OF MANAGEMENT OF NPAS:
The management of NPA is the difficult task in practice. Management of NPAs means, how to settle the NPAs account in the books. In simple it focuses on the methods of settlement of NPAs account. The methods are differs from bank to bank. The following paragraph explains some general methods of Management of NPAs by the banks. The same information is given in the chart 1.1.
Chart 1.1
General Methods of Management of NPAs
_files/image001.gif)
General
Methods of Management of NPAs
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1.6.1 Compromise:
The dictionary meaning of the term compromise is “settlement of dispute reached by mutual concessions. The following are the detailed guidelines for compromise/negotiated settlements of NPAs.
· The compromise should be a negotiated settlement under which the bank should ensure recovery of its dues to the maximum extent possible of minimum expenses.
· Proper distinction should be made between willful defaulters and borrowers defaulting in repayments due to circumstances beyond their control.
· Where security is available for assessing the realizable value, proper weight age should be given to the location, condition and marketable title and possession of sub security.
· An advantage in settlement cases is that banks can promptly recycle the funds instead of resorting to expensive recovery proceedings spread over a long period.
· All compromise proposals approved by any functionary should be promptly reported to the next higher authority for post facto scrutiny.
· Proposal for write off/ compromise should be first by a committee of senior executives of the bank.
· Special recovery cells should be set up at all regional levels.
1.6.2 Legal remedies:
The legal remedies are one of the methods of management of NPAs. The banks observed that the borrower is making willful default; no more time should be lost instituting appropriate recovery proceedings. The legal remedies are filling of civil suits.
1.6.3 Regular Training Program:
The all levels of executives are compelling to undergrowth the regular training program on credit and NPA management. It is very useful and helpful to the executives for dealing the NPAs properly.
1.6.4 Recovery Camps:
The banks should conduct the regular or periodical recovery camps in the bank premises or some other common places; such type of recovery camps reduces the level of NPAs in the Banks.
1.6.5 Write offs:
Write offs is also one of the common management techniques of NPAs. The assets are treated as loss assets, when the bank writes off the balances. The ultimate aim of the write off is to cleaning the Balance sheet.
--6--
1.6.6 Spot Visit:
The bank officials should visit to the borrowers’ business place or borrowers field regularly or periodically. It is also help full to the bank to control or reduce the NPAs limit.
1.6.7 Rehabilitation of potentially viable units:
The unit is sick due to technical obsolescence’s of inefficient management or financial irregularities. When the Bank settles the dues, of such, companies through the compromise or through the legal actions the better is to be followed.
1.6.8 Other Methods:
· Persistent phone calls.
· Media announcement.
CHAPTER: II
2.1
STATEMENT OF THE PROBLEM:
The Commercial Bank of Ethiopia has been facing numerous problems viz a dramatic hike in the bank total expenses, during the fiscal year 2001-2002, (Annual Report 2001-2002, Page No. 15), contest with private banks, (Annual report 2002-2003, Page No. 20), enormous task of creating workforces with in the skills, (Annual Report 2000-2001, Page No. 23), mobilizing deposits etc. The, most important problem is disbursement of funds in quality assets (loans and advances), the research should be identified, analyzed and possible solutions be suggested for solving the important problem.
2.2
OBJECTIVES OF THE STUDY:
The general objective of this reaserch is to analyze the NPAs in CBE. The specific objectives of this research are;
To highlight Loans and Advances trend in CBE.
To study the general reasons for assets become NPAs
To point out the amount of NPAs in CBE
To focus the amount of impairment losses in CBE
To make the suggestions to overcome the problems of CBE regarding the NPAs
2.3
REASONS FOR SELECTING CBE:
Even though there are three public sector banks and 6 private
sector banks in
--7--
2.4
SURVEY DESIGN:
The study completely depends on the secondary data. The secondary data collected from the CBE’s annual reports, NBE’s Annual reports, NBE’s quarterly bulletins, CBE’s Newsletters, CBE’s house journals, Books, Newspapers and Magazines.
2.5
DATA ANALYSIS:
After the relevant data were collected, descriptive analysis was carried out which was preferred for assessment purposes. Hence for all data interpretations were made and diagrams and graphs have been used to support discussions related to findings. Finally, conclusion and recommendations were made accordingly.
CHAPTER: III
PROBLEMS OF CBE REGARDING NPAs:
NPA reduce the yield on evidences but also reduces the profitability of CBE. The effect of NPAs can be classifies in to two categories i.e. Impact on internal factors and Impact on external factors.
3.1
Impact on internal factors:
In NPAs affect the internal position of the bank. The following are the impact of internal factors.
3.1.1 NPAs increase Total Expenditures:
The overall expenses of the bank continued to rise for a number of reasons. The Provision for doubtful accounts, that caused the dramatic increase in total expenses. The size of provision for doubtful accounts varies from year to year because of the differences in the levels of the risk anticipated. The table 3.1 gives the details about the total expenses of the Bank. The same information is given in the chart 3.1
Table 3.1
Trend of Total
Expenses
(Mn.birr)
|
Sl. No. |
Year |
Total expenses including Provision for doubtful accounts |
Total expenses excluding Provision for doubtful accounts |
|
1 |
1999 |
898 |
527.3 |
|
2 |
2000 |
701 |
619.5 |
|
3 |
2001 |
1129 |
641.7 |
|
4 |
2002 |
1512 |
884.0 |
|
5 |
2003 |
587 |
507.0 |
|
6 |
2004 |
782 |
553.0 |
Source: CBE Annual Reports
--8--
Chart: 3.1
Trend of Total
Expenses
_files/image003.gif)
The Table 5 gives a very clear picture about the differences between the total expenses, including provision and excluding provision of the CBE. The Provision for doubtful debts occupies a dominant role in the total expenses.
3.1.2 NPAs reduce the earning Capacity:
The NPA affects earning capacity of the bank. In general various causes reduce the profitability performance of the bank. The provision for doubtful debts is one among the most important cause for reducing the profitability of the bank. The table 3.2 gives a detail about Profit before tax of the bank.
Table 3.2
Profitability of
the Bank
(Mn.birr)
|
Sl.No. |
Year |
Net income Before Tax |
|
1 |
1998 |
454.4 |
|
2 |
1999 |
262.6 |
|
3 |
2000 |
619.3 |
|
4 |
2001 |
213.7 |
|
5 |
2002 |
(506) |
|
6 |
2003 |
795.0 |
|
7 |
2004 |
712.0 |
Source: CBE Annual Reports
The net income before tax for the year 2004 was 712 million Birr, which is significantly lower than that of the preceding year. In anticipation of risks stemming from unfavorable
Business conditions, weak domestic investment and business activities and the global economy, the CBE set aside a large part of its income for provisioning for doubtful accounts.
--9--
3.1.3 NPAs reduce the ROA and ROE:
NPA reduce the earning capacity of assets, return on assets also gets affected. The details of ROA and ROE of CBE are given in the table 3.3.
Table 3.3
Return on Assets
and Equity
(Mn.birr)
|
Sl.No |
Year |
ROA |
ROE |
|
1 |