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What do you mean by NPA Divergence Reporting in Banks ?
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1/ Banks give out loans to a lot of people, naturally, some of them are not able to repay their loans. If the person fails to repay interest or principal amount within 90 days of the due date, they become a Non-Performing Asset for the bank.
2/ Banks lose the interest amount as well as their capital. But they do not lose the full amount. If the collateral is attached to the defaulting loan, banks can sell the collateral and recover some amount of the loan turned bad.
3/ Banks assess what amount would be recoverable from the defaulted loan and create a provision for the amount it expects to lose. This is a subjective assessment and banks can game this. Provision is like a penalty charge for the bank. It reduces the bankâs profit.
4/ But it is necessary because in a leveraged business like banking, where things can spiral out of control very fast. Banks are funded with public deposits and RBI has to make sure that the public does not lose their money.
5/ For this reason, RBI conducts a review of how the banks have reported their NPAs, and is the provision created by them enough? If RBI finds any discrepancy like a bank giving another loan to repay the previous loan to not slip into NPA (called evergreening) or
6/ banks not creating enough provisions for their bad loans, RBI will report the âdivergenceâ of NPA in its NPA Divergence Report.
7/ Suppose a bank reported an NPA of Rs.100crs, but RBI finds the âshould beâ amount to be Rs.125crs, it will report divergence of Rs.25crs.
8/ Banks will have to rectify their accounts, showing the increased amount of NPAs as well as report more provisions that have to be created for the increased NPA. It is made to be more transparent with regard to its NPA disclosures.
9/ Banks have to disclose this divergence in 2 cases :
Case 1 - if the divergence exceeds 15% of the reported incremental NPA
Case 2 - if divergence is more than 10% of the net profit before provisions and contingencies.
Case 1 - if the divergence exceeds 15% of the reported incremental NPA
Case 2 - if divergence is more than 10% of the net profit before provisions and contingencies.
10/ RBI finding a large divergence in NPA reporting sends a very bad signal. Worse, if it happens year after year. It means that the bank is underestimating the stress in its books and is overestimating the profits by creating less provision. It is hiding stress.
11/ A prudent financial institution would faithfully report the NPA figures and create enough provision for it as well as for any other contingency. It would reduce the net profit and EPS for that period, but will make the bank stronger as bad loans would be taken care of.
12/ FUN FACT- Banks report revenue from the first EMI it receives, the actual profit for the bank comes from the last few EMIs when the principal amt is already repaid. Because of this lag, it is necessary to judge the management quality, underwriting, & disclosures of the bank.
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