The coordinated activity of an organization to realize value from assets has its own set of challenges in todays ever-growing economy. Balance, proper management and focus, among other fators, from a lender, will go a long way in lessening the gravity of the many difficulties they face in asset management.

In emerging economies, banks are more than mere agents of financial intermediation and carry the additional responsibility of achieving the government’s social agenda as well. Due to this close relationship, the growth of the overall economy is intrinsically correlated with the health of the banking industry. A strong and sustainable credit growth is almost synonymous with a healthy operating environment and strong economic growth. This trend by and large leads to healthy and profitable asset creation within the economy and the banking sector.

High growth phases
However, high growth phases also occur when stressed assets are generated within the banking sector, due to excess capacity creation, easy availability of credit, less strict underwriting and easier monitoring during such a phase but they are hidden by the growth in the economy. The above mentioned trends are visible in the graph below :

Source: Reserve Bank of India

Stressed assets
In this context, it is not surprising that in the recent past, when GDP growth has slowed down considerably, Stressed Assets of the banking sector have galloped. For the purpose of this write-up, Stress Assets are defined as ‘NPA + Restructured Standard Assets’. The trend of increase in Stressed Assets over last the 3 years has been indicated below:

% (NPA + Standard Restructured Assets)





SBI & Associates




Private Banks




Nationalized Banks




Foreign Banks








Source: Reserve Bank of India

Results of various listed banks during the current year have been an eye-opener in terms of the health of their asset books.

Also, the nature of credit in India is changing, with Infrastructure becoming a large part of the credit book and rising from 6.3% of the total credit in 2005 to around 14.4% of the total credit in 2014. Infrastructure projects are complex in nature, as they involve various interfaces, with the government and general public,which are unpredictable in nature. These are different from normal business uncertainties and require specialised appraisal skills, which have been lacking in the Indian system. Evidence of this lies in the fact that Stressed Assets in infrastructure are double the industry average, as shown below.

Stresses Assets




Banking System







Not Available

Source: Reserve Bank of India

Striking a balance
RBI has been doing a balancing act. On one hand, they have strengthened the reporting of stressed loans by introducing various SMA categories, the regulator has brought in various changes in the regulatory framework like Refinancing of Project Loans, Flexible Structuring and Funding of Cost Overruns. However,the fundamental problem of risky assets persists. The trend is likely to continue for a few more quarters as per most analysts. Further, the October 2012 Global Financial Stability Report (IMF) noted that India, together with other emerging markets, is in the late stages of the credit cycle, suggesting NPAs and debt restructurings are likely to continue rising.

Various stakeholders are looking at various options of tackling the stress in the system. Looking ahead at the next growth cycle, we believe preventing the stress would certainly be better than tackling it i.e. prudent Asset Management.

Managing assets
For any financial intermediary, the main objective of Asset Management (AM) is that while an asset is serviced on due dates, the underlying security/source of repayment remains unimpaired through close monitoring. Monitoring should be capable of picking up early signs of stress so that remedial measures can be initiated without any delay. An inability to readearly warning symptoms and laxity in monitoring would lead to impairment in the quality of the asset and eventual Non Performing Assets (NPAs). NPAs essentially imply a higher requirement of equity capital towards provisioning and an eventual write off/losses, gradually increasing the cost of debt, as a higher NPA would mean a lower credit rating and higher opex on provisioning/legal expenses/recovery efforts. If this trend is not arrested, the long-term survival of the business could be at stake.

Assesing risk
Since credit risk is integral to the lending business, no lender can avoid risk issues completely. However,a Lender needs to understand and assess various underlying risks, undertake appropriate risk management measures and price the risk appropriately. Any prudent Account Management would require a careful approach at all stages, as under:


Selection of the client: Careful scrutiny of the track record of the client with other lenders and industry references (specially with their suppliers) should be an integral part of the appraisal process. Lending should not be merely because of Advisory mandates. Where track record is concerned, one must keep in mind various instances where clients have initiated the business with very strong security (like FD/liquid shares), but once the track record has beenestablished, the client seeksa real loan, for which lenders tend to lower their guard with respect to risk assessment,leaving lenders with a sticky portfolio.


Appraisal: A compromise on the appraisal process has been the single most important reason for increasing NPAs. Lenders have been sanctioning large project loans without understanding key implementation issues and viability parameters. Once some amount has been disbursed pending approvals, the lender is caught in a downward spiral, where new disbursements are made to save old disbursements,in anticipation of delayed approvals,thereby increasing cost and impacting viability.

Proper time must be spent on the appraisal to understand each factor affecting project viability in detail. The Indian banking system has not been engaging technical experts in the pre-appraisal process. Also, the payment to these agencies by the borrower creates a conflict of interest. This is in contrary to global best practices, where technical experts are involved in the appraisal process at the lender’s cost.


Promoter’s stake: In most project loans, the actual promoter equity is small and hence the promoter’s interest is impacted by a ‘nothing at stake’ syndrome. Also, whatever equity is put by the promoter is mobilized by leveraging their stake in the company. Further, ‘gold plating’ isused extensively whereby, a higher loan is sanctioned for a project by increasing the project cost.


Very large exposures: Smaller lenders like NBFCs tend to treat single borrowers’ limit as synonymous with group exposure limit. Then,lenders tend to take the initiative of managing the account and promoters become less co-operative. Hence, the concept of sole lending is to be used very sparingly.


Substituting security for repayment: At times, a good security is treated as a substitute for an identified takeout/repayment source. The repayment in such cases is dependent on a liquidity event like sale of land, divestment in a company to PEs, IPO,etc, which are very open ended and not definite. This is imperative,as in the Indian context, the lender’s ability to liquidate security is limited due to inadequate legal framework. In such cases, the recovery prospects would be much better if the lender can sell the business. Inability to secure the loan through a pledge of 100% equity and a pledge/mortgage of the brand, has impacted recoverability in many cases.


Change of management:  It is seen that there is a minimal or substantiallydelayed use of the ‘change of management’ remedy by lenders. In cases where incompetency or diversion of funds by existing promoters is the main reason, resorting to the change of management/takeover/induction of a new strategic partner at the appropriate stage, may result in revival.

Lack of willingness on the part of lenders to step in and run a project is one of the strongest motives for borrowers defaulting. This severely diminishes the negotiating power with a rogue borrower.


Identification of various risks andmitigants and appropriate pricing of risk: It is imperative that the various risks and their respective mitigants are identified upfront. Subsequently, based on the risk, the probability of the risk becoming a reality and the strength of the mitigant, the risk must be priced right.Quite often, due to various factors like promoter profile or competition with other lenders, risks are underpriced. This leadsto a wrong pricing benchmark and limited resources being diverted to riskier projects, which lead to stress on the assets at a later stage.Thus, risks must be priced right and un-reasonable competition with other lenders must be avoided


Specialised cadre and stability of tenure: Project finance is a specialised field, where sector knowledge is essential, which is not the case with most lenders. Hence, lenders are required to create aspecialised cadre and invest in the skill enhancement of this cadre, while ensuring continuity.


Use of technology in monitoring of assets: Technology should be used extensively to monitor accounts and in the early identification of stress. An example of the same could be receiving financial/operational data from the client in a pre-designed system. The system could then analyse the data and compare it to established benchmarks/budgeted parameters.

In conclusion
The major reason for increasing NPA in the Indian context is the poor selection of a client, deficient appraisal and the lack of willingness of lenders to take-over the asset due to an inadequate legal framework. While, there is no immediate solution for legal framework, the lender needs to focus more on the selection of a client,comprehensive appraisal and the minimum relaxation/waiver approach during project implementation. Allthis will go a long way in mitigating the problems associated with ever-increasing NPAs,


Subash Chandra

Subash Chandra works as an Executive Vice President in the Asset & Structured Financeteam at IL&FS Financial Services Limited (IFIN), based in Mumbai



Opinions expressed by the Contributors are their own and do not reflect any opinion of IL&FS Financial Services on the said subject

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