Which Are High Risk Default Accounts?

Risk is the effect of uncertainty on objectives; the possibility of loss, injury, or other adverse or unwelcome circumstance; a chance or situation involving such a possibility.

Credit risk is most simply defined as the potential that a borrower will fail to meet his obligations in accordance with agreed terms.

Any measurement of risk is basically an estimate made using simple to complex statistical tools and methods. Simple way to measure risk is by application of probability theory. The probability of default is estimated by using the frequency of past missed payments. This is nothing but delinquency rate (%).

Delinquency rate is the total amount of past due as compared to the total instalments/ EMI billed/ matured, so far. This equals to ‘probability of default’.

Total receivables multiplied by delinquency rate give the total risk amount for a default account. This is very similar to the concept of LGD – Loss Given Default.

Pareto’s Principle - The 80-20 Rule

The 80/20 rule helps identifying high risk accounts. The 80/20 Rule means that in anything a few (20 percent) are vital and many (80 percent) are trivial.

You can apply the 80/20 Rule to almost anything, from the science of management to the physical world.

Applying Pareto rule here, top 20% of rank order list of defaulters based on delinquency rate can be considered as High Risk. Invariably, these high risk accounts will constitute 80% of the credit loss.

Limitation here is that some of ‘early’ defaulters on technical grounds will also appear as high risk accounts. To eliminate such accounts as high risk, DPD (90 days) is used, to differentiate. That is how our Quadrant-I accounts are classified/ segmented as “High Delinquency - High Risk”.

On follow up and serious field investigation, you will be sure to find the following in Quadrant-I:

1. Customer is not traceable
2. Asset is not traceable
3. Skip
4. Asset is with unrelated party
5. Lien is NOT marked
6. Asset is in accident condition
7. Asset is confiscated by authorities for misuse
8. Asset is attached and rotting in the Courts.
9. Asset is with a thug, lawyer or politician
10. File along with contract/ agreement is missing
11. Asset is double financed
12. Fraud

An early and serious action would help salvage; and minimize losses. Will these still constitute 80% of the credit loss?

Yes, it will.

How Does RBI Look At Default In NBFC ?

Default and Provisioning.

Asset Classification

Every non-banking financial company shall, after taking into account the degree of well defined credit weaknesses and extent of dependence on collateral security for realization, classify its lease/hire purchase assets, loans and advances and any other forms of credit into the following classes,  namely:

(i) Standard assets;

(ii) Sub-standard assets;

(iii) Doubtful assets; and

(iv) Loss assets.

The class of assets referred to above shall not be upgraded merely as a result of rescheduling, unless it satisfies the conditions required for the upgradation.

“Standard Asset” means the asset in respect of which, no default in repayment of principal or payment of interest is perceived and which does not disclose any problem nor carry more than normal risk attached to the business;

“Sub-Standard Asset” means:

(a) an asset which has been classified as non-performing asset (NPA) for a period not exceeding 18 months;

(b) an asset where the terms of the agreement regarding interest and / or principal have been renegotiated  or rescheduled or restructured after commencement  of operations, until the expiry of one year of satisfactory performance under the renegotiated or rescheduled or restructured terms.

“Doubtful Asset” means a term loan, or  a lease asset, or  a hire purchase asset, or any other asset, which remains a sub-standard asset for a period exceeding   18 months;

“Loss Asset” means:

(a) an asset which has been identified as loss asset by the non-banking financial company or its internal or external auditor or by the Reserve Bank  of India during the inspection of the non-banking financial company, to the extent it is not written off by the non-banking financial company; and

(b) an asset which is adversely affected by a potential threat of non- recoverability due to either  erosion in the value of security or non availability of security or due to any fraudulent act or omission on the part of the borrower;

‘Non-Performing Asset’ (referred to in these Directions as “NPA”) means:

a.        an asset, in respect of which, interest has remained  overdue for a period of six months or more;

b.       a term loan inclusive of unpaid interest, when the installment is overdue for a period of six months or more or on which interest amount remained overdue for a period of six months or more;

c.       a demand or call loan, which remained overdue for a period of six months or more from the date of demand or call or on which interest amount remained overdue for a period of six months or more;

d.       a bill which remains overdue for a period of six months or more;

e.       the interest in respect of a debt or the income on receivables under the head `other current assets’ in the nature of short term loans/advances, which facility remained overdue for a period of six months or more;

f.        any dues on account of sale of assets or services rendered or reimbursement of expenses incurred, which remained overdue for a period of six months or more;

g.      the lease rental and hire purchase installment, which has become overdue for a period of twelve months or more;

h.       in respect of loans, advances and other credit facilities (including bills purchased and discounted), the balance outstanding under the credit facilities (including accrued interest) made available to the same borrower/beneficiary when any of the above credit facilities becomes non-performing asset:

Provided that in the case of lease and hire purchase transactions, a non-banking financial company may classify each such account on the basis of its record of recovery;

Provisioning requirements

Every non-banking financial company shall,  after taking into account the time lag between an account becoming non-performing, its recognition as such, the realization of the security and the erosion over time in the value of security charged,  make provision against sub-standard assets, doubtful assets and loss assets as provided hereunder :-

(i)         Loss Assets: The entire asset shall be written off. If the assets are permitted to remain in the books  for  any  reason, 100% of the outstanding  should be provided for;

(ii)       Doubtful Assets:

(a)    100% provision to the extent  to  which  the advance is  not  covered  by  the  realizable value  of  the  security  to  which  the mortgage guarantee company has a  valid  recourse shall  be made. The realizable  value  is  to be  estimated  on a realistic  basis;

(b)   In regard to the secured portion, provision is to be made on the following basis  to the extent  of  20% to 100% of the secured portion depending upon  the period  for  which  the  asset has  remained doubtful:

     Period for which the asset has remained in doubtful category,

Up to one year,                                    20%

One to three years,                               30%

More than three years,                        100%

( iii)      Sub-standard assets: A general provision of 10% of total outstanding shall  be made

(iv)       Every Non Banking Financial Company shall make provision for standard assets at 0.25 percent of the outstanding, which shall not be reckoned for arriving at net NPAs. The provision towards standard assets need not be netted from gross advances but shall be shown separately as ‘Contingent Provisions against Standard Assets’ in the balance sheet.”