The Impact of Poor Loan Practices on Banks: Understanding NPA and Bad Loans
When a bank grants a loan that becomes Non-Performing Asset (NPA) or a bad loan, it can have significant financial repercussions. This article explores the mechanisms and procedures that affect banks, particularly through the lens of cash reserve ratio (CRR) and statutory liquidity ratio (SLR), and examines the critical steps in loan processing.
Understanding Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)
The Reserve Bank of India (RBI) mandates certain procedures to protect the interests of deposit customers. Two key measures are the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
Cash Reserve Ratio (CRR): The bank must deposit 4% of its net demand and time liabilities with the RBI. Statutory Liquidity Ratio (SLR): The bank must retain at least 18% of its net demand and time liabilities in form of gold, government securities, and bonds.The purpose of these reserves is to maintain bank stability and solvency by ensuring they have sufficient liquid assets to meet customer withdrawals without financial stress.
Loan Application Processing: A Stringent Process
A loan application is a formal request for money. Banks have established a rigorous process to assess these applications and minimize the risk of granting bad loans. Let's delve into this process:
Initial Application and Integrity Check
A borrower will apply for a loan, which includes submitting various documents such as proof of income, employment history, and a CIBIL report (Credit Information Bureau India Limited) to assess creditworthiness. If there are any delays in previous payments or overdue interests, these must be addressed.
Loan Sanctioning and Processing
Once the initial checks are passed, the loan officer evaluates the borrower's repayment capacity, often requiring a ratio of 50% of the gross salary as net take-home pay (after all deductions) to cover the proposed EMI (Equated Monthly Installments). Exceptions can be made if the borrower is highly deserving, and in such cases, the norm can be reduced to 40%.
Margin Requirements and Documentation
For home loans, a margin of 15% to 20% of the home value is typically required. This must be documented with proof of the upfront payment. For personal loans, no margin is required, but all documents must be thoroughly reviewed.
Discretionary powers allow officers to make judgments based on the borrower's integrity, need, and financial stability. However, these powers cannot be coerced, and the officers must act in good faith and with due diligence for the bank's benefit.
The Impact of Non-Performing Assets (NPAs)
When an advance (loan) turns into an NPA, the bank faces several issues:
No Interest Income: Since the loan does not generate interest, the bank has no source of income to cover operational costs and repay depositors. Recovery Challenges: If the loan is secured by assets, selling these assets might not cover the amount owed, leading to further financial losses. Morale and Reputation: NPA accounts can negatively impact the bank's reputation and public perception, as the society may think of loan lending as a scam.Conclusion
The bank's lending practices, guided by CRR and SLR, play a crucial role in mitigating risks. While these procedures are in place to safeguard the bank and its depositors, they also contribute to the stringent loan application process. Despite safeguards, some bad loans are inevitable, and banks must navigate these challenges to maintain financial stability.