The Role Of Banking Institutions In Any Economy

The banking institution is one of the most significant financial intermediaries in any economy. Its main purpose is to allocate funds from the areas of surplus to the areas of deficit. It also helps to get small amounts of deposits from individual small depositors and lend them in large amounts for productive purposes which in turn helps in economic growth. Banks also acts as the lubricant for the functioning of any financial industry, which means failure of such sector will affect the whole world, for example, the Global economic crisis of 2008, which affected the whole world (Crotty, 2009). In a nutshell, banks are the lifeblood of any economy (Elio Lannuzzi, 2010).

The financial reports of any bank shows different types of assets. Such assets consist of cash in hand and with other banks, call at money and short notice, fixed assets, investments, advances, loans etc. The performance of any bank depends mainly on these assets, however these assets can be performing or non-performing (Francis, 1998). When assets become Non-performing it means that there is no income which is realized from them. When assets still generate income which is expected from them and normal commercial risk is the only risk associated with it, then it is referred to as a performing asset (Miyan, 2017). The concept of Non-Performing Assets arises mainly from investments and loans. Lending process involves risk of default which affects the bank’s credit cycle (Jayanthi, 2015). When customers default in payment of their loans or when a bank made a wrong choice of its customers, the loans become non-performing assets. Despite the introduction of different policies and practices in the banking sector, NPA remains a challenge in banking sector (Zhanna Mingaleva, 2014).

Investment decision mainly depends on credit ratings of any company or country. If a bank has a high NPA value, it leads to a lower credit rating. This means it will affect its ability and power to raise new fresh capital, lowering its credibility and affecting its goodwill and brand image. If this happens, the depositors will choose to deposit their money in other banks, which affects the credit cycle and both current and future profits of a bank (Chatterjee, 2012). The problem of NPA is also causing banks to incur other costs because banks won’t have liquidity with them since their money will be blocked and causes them to borrow from other banks which requires them to pay interest. Operation of a bank will also be affected by the liquidity problem. Managerial skills are required to manage NPA in banks in order to reduce this problem (Singla D. S., 2014) Concept of Non-performing assets In general, asset means anything that can generate revenue. Asset can be physical asset or financial asset. Non-performing assets are those assets which ceases to generate profits/revenue for a specific period of time. This income can be in the form of interest or instalment of principle amount which remain due for a specific time frame.

In banking sector, or according to RBI, NPAs are categorized into 3 types which are sub-standard assets, doubtful assets and the loss assets. When a customer fails to meet his obligations for a period of 90 days, then the asset will be called as a non-performing asset. Types of NPAs Gross Non-Performing Assets (GNPA): This is the aggregate amount outstanding in the customer’s account on the balance sheet date. This also includes interest which is not yet debited from the customer’s account but has been recorded already. It includes the total of all assets which are classified as non-performing assets as per the Reserve Bank of India guidelines. Net Non-Performing Assets (NNPA): This type of NPA means the aggregate of all non-performing assets (actual) less all the provision left aside by the bank. Since there is a possibility that bad debts might happen, banks have to create a provision for bad debts. In a healthy situation, all the banks NNPA should always be close to zero, if it becomes negative then it is a very good sign that the management of NPA is properly carried out by the management. GNPA and NNPA can be expressed as a percentage by considering the total assets/lending done during the financial year (Kumar, 2014).

Asset Classification NPA has become a major problem in banking sector, which means bank managers have to make sure that this problem is prevented before it arises (Thomson, 2016). All banks have made mandatory to categorize their assets into four major classes according to their performance and how long the asset remain outstanding. Out of these four, standard assets are considered to be performing assets and the rest are considered as NPAs (RBI, 2001). These categories are: a) Standard assets b) Sub-standard assets c) Doubtful assets d) Loss assets Standard Assets are those assets which does not reveal any risk of evasion by the customer, this means it carries only a standard business risk and no such other risks. Such an asset is not an NPA. Those assets that do not create any problem while generating income for the banks comes under this category. The payment of interest and principle amount does not exceed 90 days during the financial year. If any assets failed to be in this category then it is known as a non-performing asset of a bank, and it will fall under the following categories (Kumar, 2014).

Sub-standard assets. Before March 2001, a sub-standard asset was the one which does not exceed two years but however, after March 2001 it was reduced to a period of less than or equal to 18 months. In such conditions, the existing net worth of the customer or prevailing market value of such an asset is not enough to recover all the dues to the lender in full (DAVE, 2016). In other words, these assets are well defined with credit weaknesses and characterized by the probability that a bank will incur some losses if measures are not implemented (RBI, 2001). Doubtful assets. Those assets which remained non-performing for a period of more than two years was referred to as doubtful assets. From March 2001 onwards, a doubtful asset is the one which remains due for a period of more than 18 months. These assets include all the weaknesses of sub-standard assets with extra features that it is doubtful to collect or liquidate it in full based on the known current facts, it is highly questionable as compared to sub-standard assets (RBI, 2001).

Loss assets are those assets where loss has been identified by the bank or by the external or internal auditors or by the RBI inspection. If the debt remain outstanding for a period of 36 months is treated as a loss asset, which means the bank will not be able to collect such any income from such assets. These assets should always be written off and the concept of provisioning is to address such assets. The poor the asset, the higher the provision amount which means provision on loss assets should be made 100% (DAVE, 2016). Factors that contributes to NPA NPA in India has been seen as one of the threat in banking sector. This problem is caused by both internal and external factors. Internal factors are those factors within the bank (inside) and the external factors are those factors from external environment(outside).

The following are the internal factors which contribute to NPA:

• Diversion of resources for modification or development projects.
• Less satisfaction on the credit worthiness of the customers.
• Noncompliance with the lending norms.
• Shortage of documents.
• Disproportionate overdraft lending.

However, the external factors that leads to NPA are as follows:

• Recession in the economy or world at large like that of 2008.
• Exchange rates instabilities.
• Inflation.
• Natural catastrophes and accidents.
• Changes in the government guidelines like those relating to trade activities and loan waiver schemes.

A lot of studies has been done in the area of Non-Performing Assets(loans) in India and world at large. Research articles and a lot of books in banking sector has been written to understand and solve this problem. Though research has been done, both domestic and foreign banks are still suffering from NPAs, this shows that there is something lacking. Public banks have more NPA values as compared to private and foreign banks. Among the different classification of Non-performing assets, loss assets has a significant impact on GNPAs of all the scheduled commercial banks in India (Thangavelu., 2014) (Kamra, 2013). This problem can only be resolved by the strengthening of the bank’s credit appraisal process. The increase in NPA shows the need for provisions which will then negatively affect the overall profitability of the public sector banks (Singh A. , 2013). This difference between public and private sector banks is because, the private banks are practicing a secured loan policy as compared to public banks (Rengarajan, 2016).

Public sector banks in India are not able to sustain the competition which is brought in by the new entry of both private and foreign banks. This new entry causes a lot of challenges to the public sector banks. Private sector banks have been improving due to the decline in the NPA ratios which was brought in by the proper recovery management of bank loans (Nancy Arora, 2014), this means that the public sector banks should improve their loan recovery measures. It is proven that many public sector banks are suffering from NPAs from Agriculture, small scale industries and priority sectors (Vadivalagan, 2013), in and around India. Whenever a pubic bank is giving loans, they have to access the borrower properly so as to avoid the defaults in loan payments and increase in provisions. The problem of NPA is affecting bank’s performance and profitability around the world but however, NPAs are also affecting the borrowers because it is hindering credit expansion to productive purposes which in turn affect the economy at large (Singh, 2014). This means that the problem is not affecting only public banks but all scheduled banks and the economy at large.

For the period of 2003-2013, SBI has reported more NPAs than PNB, ICICI and HDFC (Sharma, 2014). It is proven that there is a positive relationship between total advances, net profit and NPA. The increase in profits is caused by other investments of the banks and the increase in NPA is due to the wrong choice of the clients by the banks. Though the profitability of the banks increases, and NPA also increases however, there is an adverse effect on the liquidity of the banks (Singla S. N., 2014). However, low NPA increases profits together with liquidity and helps in building a brand name and cycling of banking system, this means banks are supposed to strengthen their credit evaluation norms (Laveena, 2016). Due to increase in NPA, banks will not able to give loans to new customers because they won’t have liquid cash with them. They is a need to develop a specialized skill in the area of monitoring, recovery and appraisal of loans in banks in order to ensure the quality of credit portfolio and all the relevant information should be collected from the borrowers (Thomson, 2016).

The impact of NPA on equity market capitalization has been decreasing since the financial crisis, however this decrease is not necessarily because of the proper management of NPA but there is a mismatch between the market results and the year end (Deva Dutta Dubey, 2015). NPA’s impact on share prices cannot be used in investment decision because there are other criteria to be looked at, NPA can only be used as a catalyst in investment decisions (Madhvi, 2017). Earlier research has shown that a nation with a larger population or higher GDP tend to have more advances which in turn result in higher amounts of NPA (Mahesh, 2010). So it is very important to consider the proportionate of NPA to total assets in a given financial year. More so, NPA in priority sector especially SSI’s remain higher than that of non-priority sectors (Mahesh, 2010). In reality, weak banks in terms of profitability and low liquidity ratios tend to smokescreen their real GNPA as compared to others. The true position of Indian non-performing assets is relatively wears than that which is shown in the previous studies (Rishi, 2007).

There is a need to implement international standards for the disclosure of any bad assets and credit risk in order to improve the quality of the banks in India. More than half of the NPAs in Public sector banks are from priority sector, that’s why these banks tend to have more NPA than private and foreign banks (Shajahan, 1998). Research problem The country’s economic fitness depends on the performance and the efficiency of banks in an economy. The banking system reforms such as Basel norms in India was introduced to reduce NPA levels thereby improving the performance and increasing the profitability of banks, despite these efforts, NPA remains a major problem in banking sector. The existing study tries to analyze the trend and occurrence of NPA for all Nifty bank index, significant change in NNPA during the study period and the relationship between total assets and NNPA. This study will bring light to the scholars, investors and the banking sector in general with possible solutions which can be implemented to reduce this problem.