The paper analyzes the process leading to formation and perpetuation of high levels of NPAs in Indian Public Sector Banks (PSBs). It distinguishes between random and non-random reasons of NPA formation in PSBs. It points out that a high degree of arbitrariness is involved in defining NPAs as it fails to capture diversity in terms of the seasonal and cyclical nature of the economic activities in India. The study conceptualizes random reasons for default in a simplified framework of a Poisson process. It then argues that the non-random reasons go beyond the conventional paradigm of interim, ex-ante and ex-post information asymmetries and incomplete contracts.
It points out that the financial notion of NPA as a mere risk phenomenon is inadequate, because a number of reasons leading to non-random generation of NPA are related to the dimension of uncertainty. It highlighted that the use of a secondary asset market may take care of NPA problem, but it requires a number of conditions for its use, which hardly exist in India. The study observes a number of reasons for generation of NPAs which are important and peculiar to India. This is followed by a critical evaluation of the series of policy measures that have been adopted to improve the NPA scenario since liberalization. While one set of policies granting greater autonomy to the PSBs are proved to be quite effective in restricting formation of fresh NPAs, the other set of policies designed to recover loans, after default, have failed to deliver the goods.
Finally, it concludes by making an assessment of the existing institutions and highlights the fact that the incidence of NPA is as much due to the malfunctioning of the banking institutions as due to the external institutional environment. cause, malfunctioning of the PSBs increased by the end of the 1980s. This led to the setting up of the
Narasimham Committee (1991), which, in fact, identified NPA as one of the possible causes/effects of the malfunctioning of the PSBs. In order to quantify the NPA problem, Narasimham Committee made
it mandatory on the part of the banks to publish annually the magnitude of NPAs. NPAs are those
categories of assets (advances, bills discounted, overdraft, cash credits etc.) for which any amount
remains due for a period of 180 days.2 Following the recommendations, banks started publishing in
their annual reports NPA data, which were astonishingly high. RBI (1999) report on NPA stated that
reduction in NPA should be treated as a ‘national priority’. In the Task Force3 report on NPAs in the
Indian financial system, it is argued that three NPA-ridden banks (UCO Bank, United Bank of India
and Indian Bank) are open sores threatening the health of the entire financial system. The report went
to the extent of stating that these banks were not viable candidates either for privatization or for merger,
and thus they should be closed down. The Verma Committee (1999), on the other hand, felt that these
three banks could be revived if they submit themselves to the discipline of a rigorous restructuring,
underpinned with adequate infusion of funds and simultaneous relief from the load of NPA and
excess manpower.4 The difference in the respective recommendations has provoked protests of varying
orders of frenzy, from the unionized employees. The unions have argued that the banks have been the
victims of the wilful default5 by large corporate borrowers.
Numerous studies regarding NPAs started pouring in. However, empirical works on NPA problems
of commercial banks are inadequate. Rajaraman, Bhaumik and Bhatia (1999) attempted to examine
NPA variations across Indian commercial banks. The findings show that the bank specific characteristics
such as ownership or adherence to prudential norms do not suffice to explain inter-bank variations in |
