ALM: Management of NPA

Sk. Nazibul Islam

Faculty Member, BIBM

What is a problem loan?

A loan to a borrower whose financial profile may
deteriorate or where a payment schedule has
been breached or where the banks secured
position is likely to deteriorate.
Any occurrence which may lead the bank to
believe the loan has developed a higher risk
then:
such loans will be considered problem loans and
treated accordingly.

What is NPA?
A non-performing asset in the banking sector
may be termed as an asset not contributing to
the income of the bank. In other words, it is a
zero-yield asset when applied particularly to
loans and advances.
The actual concept of NPA is that it is an asset
which ceases to yield income for the bank and
that any income accrued from such asset shall
not be treated as income until it is actually
realized.

 Classification of an asset as NPA should be

based on record of recovery.
Therefore, an asset is to be classified as NPA
when there is a threat of loss for the
recoverability is in doubt.
In spite of wide ranging reform measures
initiated in the banking sector, the problem of
non-performing assets assumed a central place
in issues relating to banking sector.

 NPA management must be thought of as an

integral part of overall credit risk management.
It implies that NPA management is not an
independent event, that starts with the conversion
of a performing loan into non-performing loan.
In fact a robust NPA management must start
before a loan becomes non-performing.
It is much better to prevent an NPA, rather than
curing or nursing an NPA.

Causes for growing Non-performing Loans

Improper selection of borrowers, inadequacies
of character, capacity and capital at the
borrowers level.
Inadequate information & improper investigation
Deficiencies in appraisal, processing, sanction
and release.
Inadequate/excess sanction of the limit
irrespective of the economic size of the unit .

 Unrealistic terms or conditions of sanction and

fixing unrealistic repayment schedule.
Political interference in sanctioning of loans and
patronage to defaulters.
Lack of infrastructural facilities like power, raw
materials, fuel, transportation, marketing and
technical support.
Lack of Inter-bank co-ordination as well as cooperation with financial institution in exchanging
information over list of defaulters.

 Defective security/shortfall in securities

/collaterals
wrong structure of loan facilities(for example,
loans were taken for industrial ventures but were
used for speculative investment in the capital
market)
weak internal cash generation process in
business leading to recurring past dues

 lending on the basis of face value of borrowers

without looking into their business
fundamentals/or future potentials
Ignorance about the competitive market
structure
economic downturn in the developed countries
as well as uncertainty in the market
weak loan appraisal and limited capacity in
understanding foreign exchange risks etc.

 Willful default is a peculiar situation for the

banks. The borrower earns sufficient income,
generates adequate surplus but deliberately
default in repayment of banks dues. Some of
the glaring examples of willful default are:
Utilization of loan to repay old debts due to the
moneylenders friends and relatives etc.
Utilization of loans towards real estate and gold
etc.

 Utilization of loan towards purchase of consumer

durables
Utilization of loan towards marriage of sisters, daughters
etc.
Utilization of loan towards professional education of
sons/daughters.
The borrowers in the initial stage of availing loan run the
business satisfactory and repay the installment timely.
Once they earn the confidence the bank, subsequently
avail large loans and refrain from paying back.

Business failure caused by overexpansion

Irregularity
Sluggish market
Depressive economic situation
Mismanagement
Bad Investment

Financing in non-viable projects

Saturated sectors
Low rate of return
Over invoicing
Too high debt-equity ratio
Faulty documentation

Consequences of NPA
recycling of lendable resources are
stopped
earnings are reduced
capital erosion happens
loan pricing shoots up
liquidity problem arise

NPA STRATEGY

RESOLUTION

PREVENTIVE

SCREENING

SURVEILLANCE

LOAN REVIEW

LEGAL

MICRO

MACRO

LEVEL

LEVEL

LOAN
WORK
OUT

NON

AMC

- LEGAL

COMPROMISE
SETTLEMENT

OTHERS

What is a delinquent account?

Any account in which the payment due has
passed and the required payment has not been
paid.
Example: If a loan payment is due on the last
day of every month, it is delinquent on the first
day of the succeeding month when the required
installment is not paid.

Why does delinquency happen?

There are two major factors which cause
delinquency:
Uncontrollable
Controllable
While some factors may be considered
uncontrollable, the Bank can still mitigate
their effects.

Uncontrollable Factor

Example

1. Natural calamities

2. Government policies

Crackdown on street
vendors, increased
taxes, relocation of
public market

3. Loss of economically
active
members of the
household

Death, illness

4. Slowdown in the growth

of
local or national
economy

Increasing food prices

5. Low market price for

Over supply of fish

Typhoons, fires, drought

Controllable Factor

Example

1. Lack of clear-cut and

consistent lending and
collection policies

Absence of collection
procedures
Absence of loan policies
relating to loan
information
requirements, collateral,
etc.

2. Delinquency control is
not a priority

There is very little effort

to collect
Banks staff complacent
in collection
Supervisory Board does
not prioritize formulation
of loan and collection
policies

Controllable Factor

Example

3. Officers have insufficient Collectors or loan

knowledge, experience
officers who prefer or
and skills in lending and
are more suited to
collecting resulting in
office-work types
poor collection methods
4. Lack of clear records

No aging reports

5. Absence of incentives to
good
payers and absence or
inadequate penalties for
late
payments

Delinquent borrowers
get repeat loans

Delinquent Loans

Provisions required
Early action can protect the bank rather
than waiting

Delinquent borrowers-Collection tactics

Stay calm. Never refuse to listen.
Do not interrupt. Give the borrower a
chance to explain.
Show understanding. Let him know you
can identify yourself with the situation.
Try not to disagree with the customer.
Respect the customers dignity and avoid
embarrassment.

 Identify the problem. Make sure you understand

the situation.
Find some solutions. Come up with a
compromise.
Keep smiling. Keep your mood positive.
At the end of the meeting, ask the customer if he
has any questions or concerns; and
Thank the customer for their time.

Management of Problem Loans

Prompt action
Problem loan report
Inclusions in report

Management of Problem Loans

As soon as loan becomes a problem necessary
to set up a collection process.
Specify loan amount due and value of security
associated with the loan.
Write to customer under guidance of banks
lawyers.
Request interest/principal payment due, within a
specified number of days.

 Despite a prudent credit approval process,

loans may still become troubled.
Therefore, it is essential that early
identification and prompt reporting of
deteriorating credit signs be done to
ensure swift action to protect the Banks
interest.

Detection of Problem Loans

Most common areas of upcoming

problems:
Declining sales
Deteriorating Receivables
Inadequate cash flow (refer cash flow
projections)
Inventory turnover

 Slowdown in the trade payables

Industry problems (a slump or severe
competition)
A change in Management or ownership
(may change direction of the business)
Almost 60 items to watch for.

 An Early Alert Account is one that has risks or potential

weaknesses of a material nature requiring monitoring,
supervision, or close attention by management.
If these weaknesses are left uncorrected, they may result
in deterioration of the repayment prospects for the asset or
in the Banks credit position at some future date with a
likely prospect of being downgraded or worse (Impaired
status), within the next twelve months.
Early identification, prompt reporting and proactive
management of Early Alert Accounts are prime credit
responsibilities of all Relationship Managers and must be
undertaken on a continuous basis.

Management of Problem Loans

Arrange for a meeting (soft option) with customer,
to establish
1. if management is able to make loan repayment and
if not then see
2. If he/she is willing to proceed to a joint work out
situation.
one week to respond.
if un successful in arranging meeting, then lawyers
letter to issue to customer demanding repayment in
full within a specified time frame.

Initial Loan Recovery Process

Process
1. Amicable (Pre-legal)
2. Aggressive (Pre-legal
but with threat of legal
action

Action

1. Phone call / personal

visit (immediate upon
default)
2. Personal visit.(we may
have to give this matter
3. Demand for payments
to our lawyers)
(letter from lawyers)
3. Aggressive letter to
borrower and guarantor
4. Legal action ( in courts)
(signed by legal counsel)
4. Can take various forms:
Demand for payments in
arrears
Loan contract foreclosure
(payment of arrears and
future obligations and
penalty)
Collateral foreclosure
Execution of guarantees

Borrowers Attitude
Important to establish borrowers attitude to the repayment

Position

Solution

1. Borrower cannot pay

under any circumstances

1. Foreclosure on collateral,
charge off the remainder.

2. Borrower can pay, but with 2. Reschedule/restructure

rescheduling/restructuring
following negotiation
3. Borrower can pay but
refuses to pay

3. Immediate legal action,

collateral foreclosure,
seizure of any other
identifiable/available
assets (of the business) or
in the case of a guarantee
personal assets.

Problem loans- Collection

Advise customer if failure to repay then
under terms of mortgage it is your
intention to sell the property upon court
approval (if required), without further
contact to customer.

Problem loans- Move to recovery Department

At this point recovery department/unit

become involved and again efforts are
made to meet with customer and undertake
a joint workout programme.
Customer to be advised this is not
necessarily a sell off.
You are trying to help the company survive
and reduce the bank debt at the same time.

Problem loans- Priority

Remember the priority at all

times is to recover the debt.
That is your job.
Always remember that.

Problem loans- Methodologies

A very difficult experience with serious
antagonism from within the business very
likely.
Important to get the companys team on
your side-to work with you.
Clearly they must realize you are trying to
save their jobs and the business as well as
trying to get the bank debt reduced to an
acceptable level.

List Assets
As soon as the loan comes under the jurisdiction
of the recovery department, a list is made of all
of the:
- loans owing by the business to your bank and
others
- businesss assets short and long term.
(balance sheet valuations)
- business liabilities
Revalue realistically the assets.

Work-Out Procedures
Establishing Course of Action
Exercise strong legal
collection Action
e.g. uncooperative
professional avoiding
payment commitments.

Recommend write-off

e.g. customer is
imprisoned or has left

Grant Payment
Extension

e.g. professional
person experiencing
employment
difficulties
Restructure Deal, may
include partial write
off
e.g. low income

Rescheduling

Loan scheduling 1st time:

Avoid routine rescheduling
Examine causes for rescheduling
Down payment 15% of overdue installments or
10% of total amount of loan outstanding
whichever is less.

2nd time rescheduling:

30% of overdue installments or 20% of
total loan outstanding whichever is less.
3rd time rescheduling:
50% of overdue installments or 30% of
total amount outstanding.

 Therefore, it is essential that early identification and

prompt reporting of deteriorating credit signs be done
to ensure swift action to protect the Banks interest.
An account may be reclassified as a Regular Account
from Early Alert Account status when the symptom, or
symptoms, causing the Early Alert classification have
been regularized or no longer exist.
The concurrence of the CRM approval authority is
required for conversion from Early Alert Account status to
Regular Account status.

Corrective Measures:
- Legal Review of Docs & Situation
- Workout Strategy & Action
- Loss Evaluation vs. Security Cover
- Stay or Leave Decision & Reclassification
- Continuous Visits to the Client (Defaulter)
- Negotiation vs. Court Action

Thank You