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Indian Banking Today & Tomorrow - Performance
Assessment of Banks
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Prudential Norms are intended for ensuring greater transparency and securing the long-term sustainability of Banks. These are Income Recognition - Interest income should not be recognized until it is realized. An NPA is one where interest is overdue for two quarters or more. In respect of NPAs, interest is not to be recognized on accrual basis, but is to be treated as income only when actually received. Income in respect of accounts coming under Health Code 5 to 8 should not be recognized until it is realized. As regards to accounts classified in Health Code 4, RBI has advised the banks to evolve a realistic system for income recognition based on the prospect of realizability of the security. On non-performing accounts the banks should not charge or take into account the interest. On overdue bill, interest should not be charged or taken at income unless realized. Asset Classification - The banks should classify their assets based on weaknesses and dependency on collateral securities into four categories:
Provisioning Norms- Based on the asset classification, banks will have to make the following provisioning:
[Non-Performing Assets (NPAs):These are the loan assets of the banks, where the borrower defaults or delays payment of interest and principal amount for more than two quarters.] The expenditure statement includes expenses arising from their intermediation activity i.e. the interest cost on the funds mobilized and the intermediation costs incurred in the process of extending the banking services. As far as the interest costs are concerned, the prevailing interest rate structure will be a major deciding factor for the rates. But what influences both the interest costs and the intermediation costs is the time factor as it is directly related to costs. The solution for these two influencing factors lies predominantly on technology. Through advanced technology, banks will be able to design newer products and ensure lower cost of funds and better customer service. In essence, technology enables cost-effective intermediation. The centralized databases that can be set up using intensive technology will ensure faster decision-making, thereby lowering the cost of operations substantially. In this regard, the new private banks and the foreign banks, which are equipped with the latest technology, have a better edge over the nationalized banks, which are yet to be automated at the branch level. The difference between the total income and the total expenses of the banks gives the pre-tax income. However, considering the intermediation function, it is the net interest income (NII) that is more crucial for the banks. NII (or "spread") is the difference between the interest income and the interest expenses. Spread is the bread for banks. For the long-term sustenance of the bank, this should be positive. In a deregulated interest rate environment, the market plays a critical role deciding the interest rates. In addition to the pressure built by competition for the deposits and is thereby affecting the NII. On the other hand is the non-interest income (other income) and the non-interest expenses of the bank, the difference between which is known as the 'Burden'. This is generally negative due to the low level of fee based activities. This trend is however changing. With the building of pressure on the interest income, banks are now trying to increase their non-fund-based income also. Apart from the interest rate structure, the net interest income is also affected by the asset quality of the bank. Asset quality is reflected by the quantum of non-performing assets (NPAs) - the higher the level of NPAs, the lower will be the asset quality and vice versa. Courtesy the nationalization agenda and the directed credit, most of the public sector banks were burdened with huge NPAs. While the government did contribute to write-off these bad loans, the problem still remains. If the NPAs are not recognized and disclosed it will present an entirely wrong picture of the Bank's performance. NPAs expose the banks to not just credit risk but also to liquidity risk. Considering the implications of the NPAs and also for imparting greater transparency and accountability in banks operations and restoring the credibility of confidence in the Indian financial system, the RBI introduced prudential norms and regulations. The asset quality of the bank and its capital are closely associated. If the assets of the bank go bad it is the capital that comes to its rescue. Implies that the bank should have adequate capital to face the likely losses that may arise from its risky assets. In the changed business environment, where banks are exposed to greater and different types of risk, it becomes essential to have a good capital base, which can help it sustain unforeseen losses. The one major move in this direction was brought about by the Basle Committee, which laid the capital standards that banks have to maintain. This became imperative, as banks began to cross over their national boundaries and begin to operate in international markets. Following the Basle Committee measures, RBI also issued the Capital Adequacy Norms for the Indian banks also. The growing concern of commercial banks regarding international competitiveness and capital ratios led to the Basle Capital Accord 1988. The accord sets down the agreement among the G-10 central banks to apply common minimum capital standards to their banking industries, to be achieved by year end 1992. The standards are almost entirely addressed to credit risk, the main risk incurred by banks. The document consists of two main sections, which cover (a) the definition of capital and (b) the structure of risk weights. For complete details, please refer the web page on Basle Accord Based on the Basle norms, the RBI also issued similar capital adequacy norms for the Indian banks. According to these guidelines, the banks will have to identify their Tier-I and Tier-II capital and assign risk weights to the assets. Having done this they will have to assess the Capital to Risk Weighted Assets Ratio (CRAR). The minimum CAR which the Indian banks are required to meet is set at 9 percent. Tier-I Capital
[Note: Equity investments in subsidiaries, intangible assets and losses in the current period and those brought forward from previous periods, will be deducted from Tier I capital.] Tier-II Capital
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