r gandhi : growing npas in banks – efficacy of ratings accountability and transparency of credit rating agencies speech by mr r gandhi, deputy governor of the reserve bank of india, at the conference conducted by assocham ( associated chambers of commerce and industry of india ), new delhi, 31 may 2014. * * * assistance provided by shri d. r. dogra and shri nethaji b is gratefully acknowledged. shri jajodia, shri narang, shri dubey, shri kulkarni, shri dogra, shri khanna, shri pathak, other distinguished speakers, ladies and gentlemen, a very good morning to everyone! to start with i would like to commend assocham for this seminar, for bringing together experts from banking and rating industry, to discuss and debate upon this very pertinent and challenging subject of npas and credit rating. a subject like this needs a lot of discussion and thinking, because there are evidently no easy answers ; if they existed, we would not be in this state. in a way the last three years were wake - up calls for us ; with the downturn in economic activity, the cracks in our credit appraisal and monitoring system have appeared and we should get our act together to repair the structures. this conference provides an opportunity to get additional insights into credit risk assessment and mitigation in addition to getting to know the views of such a diverse and experienced panel of industry experts. asset quality as the conference is being held in the context of growing non - performing assets ( npas ) of indian banks, let me begin with few statistics relating to npas to put things in perspective. before 2008, asset quality of scbs was improving on a secular basis, following implementation of prudential guidelines since mid 1990s. the gnpa ratio had declined sharply from 12. 0 per cent as at end march 2001 to 3. 5 per cent as at end march 2006 and thereafter this ratio was flat till march 2011. however, since then, the npa of the banks has been increasing ; as at the end of dec 2013, the gross npas of the domestic banking system was 4. 40 per cent of gross advances. the final figure for mar 2014 is yet to be known ; while some may view this ratio as reasonable given the economic conditions prevalent in the country and elsewhere, the total stressed assets in the banking system ( which includes npas and restructured standard assets ) as at dec 2013 was 10. 13

to appreciate that the credit process in case of micro and small entrepreneurs cannot be identical to that of large corporations, where the borrower is able to provide detailed information about business plans and the firm ’ s financial statements and the lender carefully reviews the data using analytics that are time - consuming and expensive. in view of the relatively small size of the loan, banks do not find it worthwhile to conduct an elaborate appraisal of sme credit proposals both in terms of value and profit. therefore, in order that the banks can quickly conduct appraisal of sme loan proposals without expending too much resources, it would be imperative to ensure the efficiency of the appraisal process. an important dimension to efficiency in the context of lending decisions is the speed with which any individual lending decision is taken. efficiency is improved by better evaluation of future payment performance so that the lender is able to choose whom to accept and whom not to accept. 11. financial institutions in the developed countries use a number of different lending techniques to address this challenge and provide funding to small firms. the banks, in these countries, use a version of a computerized loan - evaluation system, referred to as credit scoring, to assess would - be borrowers. the credit scoring approach, which is based on use of computer technology and mass production methods, was originally designed to handle consumer loans, but are now being used effectively for lending to small businesses by predicting their potential loan delinquency. credit scoring offers a modern alternative for the traditional method of evaluating loans for small businesses where loans were approved on the basis of the banker ’ s qualitative judgment and the financial condition carried significant weight in the appraisal process. 12. with a view to expediting the flow of credit to the mse firms, rbi, as a proactive measure, issued guidelines in may 2009, advising banks to start using scoring models for making lending decisions in case of all advances up to rs. 2 crore. however, despite, our instructions having been issued nearly five years back, we find that use of credit scoring model in the real sense has not really taken off in india. our assessment is that perhaps the lack of conceptual clarity on the subject could be one of the reasons for banks ’ reluctance in using the credit scoring model for making mse lending decisions. in fact, very often credit scoring is misunderstood or confused with credit rating. in the next segment of my talk today, bis central bankers ’ speeches i would,