The old dictums “Prevention is better than cure” and “A stich in time saves nine” are very much applicable and relevant in the matter of classifying the account as Non-Performing Asset (NPA). The health and sustaining power of any commercial organization depend upon how they manage their cash flows and fund flows to meet their financial commitments and other obligations. In the language of a lay man cash flow means liquidity by way of cash on hand, bank balance and any other liquid assets readily available to meet any contingencies or financial obligations at any point of time after effectively sourcing the funds and deploying it creating a cash surplus. Hence, it is inevitable that a pragmatic and realistic cash flow is assessed at the time of appraisal of the project implementation while sanctioning the loan by the bank and financial Institution so that the financial obligations and commitment of the business are met without any impediments. Fund flow means how the funds are sourced and deployed for obtaining the optimum result. Therefore, assessment of a realistic cash flow should be the focus while appraising a project financing and to meet the working capital requirements. After having appraised and arrived at the financial needs of the borrower, implementable terms and conditions of the sanction are to be stipulated without any onerous clause and the involvement of the borrower should be ensured during the process of appraisal and assessment of project and to arrive at its terms and conditions by way of discussion and negotiation between the lender and the borrower.
One of the most important aspects of credit appraisal is the assessment of risk factors. “Credit risk is defined as the possibility of losses associated with diminution in the credit quality of borrowers or counter parties. In a bank’s portfolio, losses stem from outright default due to inability or unwillingness of a customer or counter party to meet commitments in relation to lending, trading, settlement and other financial transactions. Alternatively, losses result from reduction in portfolio value arising from actual or perceived deterioration in credit quality. Credit risk emanates from a bank’s dealings with an individual, corporate, bank, financial institution or a sovereign.” The following are the three basic areas of credit risk management namely (i) Policy and Strategy (ii) Organizational Structure and (iii) Operations and systems.
The imperative need is to maintain the quality and value of the assets throughout the pendency of the loan. The bank should always ensure that they have efficient and robust risk management systems in place. After having sanctioned adequate and appropriate financial facilities by way term loan and working capital or both, as the case may be, timely release of funds is to be ensured to complete the implementation of the project as per the schedule of implementation projected in the project report appraised by the bank. Any delay to release the funds as per the envisaged schedule may create cost escalation and liquidity crisis affecting early cash generation delaying the project implementation which may even lead to the unit becoming sick in the early stages.
The effectiveness of the action taken to prevent the account being classified as NPA depends upon the post sanction credit monitoring steps taken by the bank and financial institutions. The credit monitoring of operations begins immediately after the first disbursement of the loans sanctioned after complying with the terms and conditions of sanction by the borrower. The project implementation is to be monitored at regular intervals and if any impediment is found, corrective steps are to be taken immediately depending upon the nature of impediment by re-assessing the financial needs depending upon the situation prevailing then and undertaking restructuring of the loan components to arrest the deteriorating trend.
Project management and working capital management are the two important functions of any commercial organization. Facilities are given by the financial institution and bank for specific purposes and if the funds are diverted and utilized for any other activity other than for the purpose for which they are sanctioned, then it will lead to severe liquidity crisis leading to creation of non-performing asset. One of the important functions under credit monitoring is to prevent diversion of funds. The participation of the borrower is to be ensured in the process of credit monitoring which will not only educate the borrower about the intricacies of project and working capital management but also make the borrower to take steps for the good governance of his enterprise.
What is happening now is that by the time the banks start their restructuring process, it is too late to retrieve the situation both in terms of rehabilitation of the project and recovery of bank dues. Hence, identification of the causes for the account becoming NPA from the very beginning when the account starts showing the first signs of distress / weaknesses irrespective of the fact that the account may or may not become NPA is very much imperative.
The success of any restructuring scheme depends upon the capacity of the borrower to keep up his financial commitments to the financial institutions and creditors and his commitment can be ensured only if the cash flow Is assured and ensured through his business activities. Hence, it is inevitable and essential that while undertaking any restructuring scheme to prevent the account being classified as NPA and avoid invoking recovery proceedings of the loan, a realistic cash flow and fund flow study must be undertaken which will ensure continuous and uninterrupted cash flow.
The health and liquidity of banks depend upon timely recovery of their investments with their expected return on their investments. Recovery consists of two important components namely servicing of interest on loans in case of working capital and its timely renewal and timely payment of installments and servicing of interest in the case of term loans. Hence, it is imperative on the part of banks to appraise and assess the capacity of the borrowers to meet their financial commitments and obligations not only towards servicing of interest and repayment of loans and advances sanctioned by the bank but also to meet other business commitments. Besides, an effective monitoring system should be implemented on a continuous basis without complacency and slackness keeping a tight vigil through by identifying competent and knowledgeable employees and giving them suitable training so that they are equipped to take immediate remedial steps to prevent the account from classifying as NPA.
The health of any commercial organization depends upon the liquidity position of the enterprise. Liquidity position is determined by the cash flow being generated out of business activities. Operating any business in today’s economic environment means managing cash flow. Companies looking only at their earnings and not managing cash flow cannot and will not survive in today’s economy where short term operational loans are not often readily available. Hence, managing a very positive cash flow is an essential and an inevitable necessity for any business organization to prevent the account being classified as NPA.
(The author can be contacted through his e-mail: [email protected] and he also invites comments from readers.)