The present Indian Banking System is constituted by a number of institutions comprising Reserve Bank of India, Indian Commercial Banks, Co-operative Banks. Regional. Rural Banks, Foreign Banks and other specialized banking institutions. The existing banks can be classified into different groups. The public sector banks are divided into- nationalized banks and SBI and its associate banks, where there are 19 in former and 8 in latter. State Bank of India occupies a special status in the Indian Banking System. Shri C.N. Vakil, while describing the importance of State Bank of India, states: “Though it is the function of Reserve bank of India to maintain the stability of currency and credit, to regulate the affairs of the banks and help in the development of banking, the leader of banking system in India is the State Bank of India (Vakil, 1974).

The State Bank of India was the outcome of the implementation of the recommendations of the committee of Directors of All India Rural Credit Survey appointed by the Reserve Bank of India in 1951, for providing banking facilities to rural and semi-urban areas. Following the recommendations of the committee, the Government of India, decided to take over the ownership and management of the Imperial Bank of India and therefore the State Bank of India was formed in 1955. In order to achieve the objectives of providing banking facilities to neglected areas, in 1959 State Bank (Subsidiary Banks) Act was passed and as a result State Bank of Hyderabad, State Bank of Bikaner and Jaipur, State Bank of Indore, State Bank of Mysore, State Bank of Patiala, State Bank of Saurashtra and State Bank of Travancore became subsidiaries of State Bank of India. The subsidiary banks, being autonomous, continue to maintain their individual identity and independence in their functioning while the State Bank of India is vested with the general power of control, supervision and direction. The State Bank of India was established basically with the objective of providing banking facilities to neglected areas. Specifically its role was to promote agricultural finance and to extend credit facilities to cooperative undertaking, self-employed engineers and technicians and small scale and cottage industries. It was hoped that the bank will help the Reserve Bank of India in the implementation of credit policies and to check any monetary disequilibrium likely to develop in the money market owing to the developmental activities. In order to ensure the economic development of the country in desired directions having regard to socio- economic conditions prevailing in the country, fourteen major commercial banks were nationalised in July, 1969. These banks are Central Bank of India, Bank of India, Punjab National Bank, Bank of Baroda, United Commerical Bank, Canara Bank, United Bank of India, Syndicate Bank, Dena Bank, Union Bank of India, Allahabad Bank, Indian Bank, Bank of Maharashtra and Indian Overseas Bank. On April 15, 1980 six more banks in the private sector whose demand and time liabilities amounted to more than Rs. 200 crores were nationalized. These banks are: Andhra Bank, Oriental Bank of Commerce, Corporation Bank, New Bank of India, Punjab and Sind Bank and Vijaya Bank. With the addition of these banks the number of public sector banks has increased to 28, which comprises 20 nationalized banks and eight banks of the State Bank Group. Later the New Bank of India merged with Punjab National Bank. At present, there are 27 public sector banks including 7 subsidiary of State Bank of India. The PSBs had 48,150 offices (SBI and Associates: 13739; Nationalised Banks : 34,411) and their assets of Rs. 14,714 billion at the end of financial year 2004, which is 74.5 percent of assets of all schedule commercial banks in India. An estimated 63.1% of the offices of PSBs are in rural/semi-urban areas. Finance is the life blood of economic development. It helps in capital formation and capital accumulation, which is very necessary for building infrastructure and setting up of basic and key industries which are essential for long-term development. A developing economy faces many problems like poverty, scarcity of capital and lack of entrepreneurship. There is dependence on agriculture and at the same time agriculture is not modernized. Means of transport are underdeveloped. There are inter-regional and inter-sectoral disparities. There is unequal distributions of wealth. Banks can work as catalytic agents of growth by following the right kind of policies in their working, depending upon the socio-economic conditions prevailing in a country. It is realized that since the banks have stupendous investment potentiality they can make a significant contribution in eradicating poverty, unemployment and they can bring about progressive reduction of inter- regional, interstate and inter- sectoral disparities (Biegrami, 1982). In this way, the public sector banks render vital services to the masses belonging to the various sectors of the economy like agriculture, industry whether small scale or large scale and to the tertiary sector. The public sector banks help the development of the industrial sector by providing short term, medium term and long term loans to industry. Besides this, public sectors banks also grant loans to small scale industrial units for expansion, modernization and renovation proposes. Thus, public sectors banks not only provide finance for industry but also help in activating the capital market which is undeveloped in growing economies. The public sector banks help in developing both internal and external trade of a country. The banks provide loans to retailers and wholesalers for their inventory. They also help in the movement of goods from one place to another by providing all types of facilities, such as discounting and accepting bills of exchange, providing overdraft facilities, issuing drafts etc. Moreover, they finance for both exports and imports by providing foreign exchange facilities to importers and exporters of goods (Aggarwal, 1981). The public sector banks help the large agricultural sector in a number of ways. They open a network of branches in rural areas to provide agricultural credit. The public sector banks advance credit for the development of employment generating activities in developing countries. They provide loans for the education of young persons studying in engineering, medical and other vocational institutions of higher learning in cheaper interest rate.

Financial Sector Reform and PSBs:

Organised reform of the financial system began in 1991 on the basis of the recommendation of the Narsimhan Commitee-1, as a part of the general economic reforms. RBI had introduced a large package of reform, step by step, covering the entire financial system. Both structural and functional changes were brought about in the capital market, banking sector, external sector and foreign exchange market. The objectives of Jha financial reform were (a) growth of output (b) bringing stability in the price systemic) allocation of financial resources through market mechanism to Unproductive sector and (d) improvement of efficiency in the financial system which was suffering from bad debt, loss and erosion of capital structure. First phase of reform has brought about significant changes in the functioning of the entire banking sector. Asset management, soundness in capital structure, technological up-gradation are some of the important changes that have come about in the banking operations. Specifically, private sector banks have been permitted to compete with the public sector banks. Some public sector banks have also been selected for autonomous status so that they can independently function in the competitive market. Gradually, the government is goading the banks to the capital market for raising capital and leasing to provide fund for re-capitalization of the sick bank. RBI has implemented the capital adequacy norms of Basel international standard and asked banks to strictly implement it. Banks were given detailed guidelines for management of different kinds of risks that are likely to crop up with liberalization such as credit risk, liquidity risk, currency risk and country risks. Further, RBI has asked all the banks to provide more information in the balance-sheet regarding maturity pattern of loans and advances, investment’ securities, deposits and borrowings, foreign currency, assets and liabilities and NPAs. Currently banks are operating in global environment which is not only competitive but uncertain and risky. To be competitive, banks are introducing wide range of products and services and going for computerization in big way to improve the speed of their operations to satisfy their customers who are becoming highly demanding. Banks are now faced with various type of risks not because of factors related to fast development of newer products /services and speed of their operations, but also due to their cross border dealings, general decline of public moral values adversely affecting loan recovery, slow and expensive legal process etc. The various risks faced by the banks can cause volatility of net interest margin (NIM) in short term time horizon and threat to net economic value of the organization in the long term time horizon. The banking risks can be categorized under two main heads viz. Business Related risks which are linked with their various operational activities and control related risks that arise out of absence/lack of control and supervisory system.

Credit Risk:

Banks as intermediaries between ‘savers’ and ‘investors’ accept deposits from public and lend them to entrepreneurs to earn profits. Once the money is lent, the borrowers are supposed to return that lent money and the interest thereon. Thus, every credit decision implies that the borrower’s financial position will remain steady and improve throughout. This however, need not necessarily be true always as the projected cash flows are always impacted by market variables like interest rate hikes and accompanying liquidity strains, increased competition, business cycles, economic and fiscal policies of Government and International bodies like bank for international settlement. Hence, repayments are not always certain. There is ample scope for a borrower to default from his commitments resulting in credit risk to a bank. Credit risk is the potential loss that a bank may be subjected to because of inability of a counter party (borrower) to meet its (his) obligations. It is defined by the losses in case of default of a borrower or in the event of a deterioration of the borrower’s credit quality The assets of a bank whether a loan or investment carries credit risk. It simply define as the potential that a bank. borrower or counter party will fail to meet its obligations in accordance with agreed terms. Credit risk is defined by the Reserve Bank of India as the possibility of losses associated with diminution in the credit quality of borrowers or counterparties. It involves inability or unwillingness of a customer to meet commitments in relation to lending, trading, hedging, 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 dealing with an individual, corporate, bank, financial institution. In view of above mentioned developments the financial market is now more vulnerable and risky than in the past. Banks in the process of financial Intermediation are facing various kinds of financial and non financial risk viz. credit risk, liquidity risk, operational risk etc. These risks are highly interdependent. However, Indian banks particularly Public Sector Banks have little idea about what is risk, when and where it occurs, how to measure it and how risk can be repelled or avoided. Thus, the most critical task before bank management is to put in place sound participation and framework of risk management and control. The Reserve Bank of India has issued comprehensive guidelines to banks asking to put in place proper risk management structure to improve the ability to identify, measure, monitor and control the overall level of risk undertaken. Public Sector banks should assess their risk properly, maintain NPAs and Capital Adequacy Ratio within limit fixed by the RBI and Basel Accord. Taking above facts into consideration the present study aims to make a systematic study on risk management in Indian Public Sector banks.

REVIEW OF LITERATURE:

Dangal and Zechner (2004) studied on credit risk and dynamic capital structure choice. This paper analyzes the effect of dynamic capital structure adjustment on credit risk. The study finds that the under estimation of credit spreads and expected defaults frequencies is exacerbated when the risk adjusted drift of the underlying stochastic process is inferred form a model which ignores the opportunity to recapitalize. Finally, it is shown that the value- at- risk of corporate bonds increases with the distance to default (DD) both for very low and for very high values of DD whereas it decreases for intermediate values, Jimene and Savrina (2004) in their study on collateral, type of lender and relationship banks as determinants of credit risk, explain the determinants of the probability of default (PD) of bank loan. The study uses information for more than three million loans, entered in to by Spanish credit institutions over a complete business cycle (1988- 2000) collected by the Bank of spain’s credit Register. The finding of the study is that collateralized loans have a higher PD, loans granted by saving banks are risky and finally, that a close bank borrower relationship increases the willingness to take more risk. Instefjord (2005) in his study on “Risk and hedging: Do credit derivatives increase bank risk” investigates whether financial innovations of credit derivatives make banks more exposed to credit risk. His analysis identifies two effects of credit derivatives innovation (I) they enhance risk sharing as suggested by the hedging argument and (II) they also make further acquisition of risk more attractive. Mohan and Roy (2004) attempt a comparison of performance among three categories of banks - public, private and foreign- using physical quantities of input and outputs, and comparing the revenue maximization efficiency of banks during the period 1992-2000. The findings of the study shows that PSBs performed significantly better than private sector banks, but no differently from foreign banks. Dangal and Lehar (2004) study on value-at-risk vs. building flock regulation in banking examines the effect of specific regulatory capital requirements on the risk- taking behavior of banks. The main findings of the study is that value at-risk based capital requirement creates a stronger incentive to reduce asset risk when banks are solvent Kao and Liu (2004) in their study on bank performance with financial forecasts, have predicted the performance of 24 commercial banks in Taiwan based on their financial forecasting. They have used a DEA model for internal data is formulated to predict the efficiency of these banks. Sastri, Samuel and Daran’s (2004) study on, “income stability of scheduled commercial banks : Interest vis-a- vis non interest income” attempts to compare the behavior of interest and non-interest income of scheduled commercial banks in India during the period from 1997 to 2003. The paper further tries to examine whether non- interest income has helped in stabilizing the total income of schedules commercial banks in the country. The study uses a number of statistical tools like the mean, standard deviation (SD) and coefficient of variance (CV). The main findings of the study is that the average net interest income of scheduled commercial banks declined during the period 1997 to 2003, but the stability of the net income has improved during this period. Ranjan Rajiv and Dhal Sarat Chandra (2003), study on, “non- performing loans and term of credit of public sector banks in India : an empirical assessment”, explores an empirical approach to the analysis of commercial banks, non-performing loans (NPLs) in the Indian Context. The study evaluates as to how banks’ non-performing loans are influenced by three major sets of economic and financial factors, i.e., terms of credit, bank size induced risk preferences and macro economic shocks. The empirical results from panel regression model suggest that terms of credit variables have significant effect on the bank’s non-performing loans in the presence of bank size induced risk preference and macro economic shocks. Moreover, alternative measures of bank size could give rise to differential impact on bank’s non-performing loans. In regard to terms of credit variables, changes in the cost of credit in terms of expectation of higher interest rate induce rise in NPAs. On the other hand, factors like horizon of maturity of credit, better credit culture, favorable macro economics and business conditions lead to lowering of NPAs. Business cycle may have differential implications advancing to differential response of borrowers and lenders. Further, the study suggest appropriate credit culture and lending policy designated with relevant economic and financial factors constituting the terms of credit which will make a significant impact on banks non-performing loans

OBJECTIVE:

The study primarily focuses on overall evaluation of risk management system adopted by Indian Public Sector banks the objective of the study here is to

· To evaluate credit risk of public sector banks

· To study the impact of credit risk on performance of public sector banks

METHODOLOGY AND DATA:

The study is based on the primary as well as secondary sources. The study used data published by the RBI, Annual Report, Banking Report, statistical table relating to banking in India, Report on trend and progress of banking in India, Centre for monitoring Indian economy (CIME), IBA Bulletin etc. So far as primary data is concerned, sample Public Sector banks would be visited for the purpose of study of their risk management policies, process and systems. The method of data collection in this regard will be mainly through personal interviews and discussion with the senior executives of respective bank to understand bank’s strategies, plans and progress in measuring and controlling various risks. But for assessing credit risk the study uses ordinary least square (OLS). To judge the extent to which the public sector banks have been able to meet the challenges of credit risk the study has used coverage ratio propounded by Gonzalez-Hermosillo (1999). The data relating to non-performing assets of public sector banks, which could help in assessing the magnitude of influence the non-performing assets have, on some selected variables, taken from the consolidated balance sheet and profit and loss account of State bank of India. It has almost become axiomatic that the presence of NPAs in public sector Banks books is unavoidable and their impact inevitable, irrespective of the fact that a bank is weak or strong. What is relevant is whether it is kept at reasonable level. Therefore, attempt is made to calculate the extent of NPAs of SBIs, their relationship and their impact on important micro level variables.

FINDINGS AND DISCUSSIONS:

NPAs is a part of gross advances. As and when credit expansion takes place, some seeds of NPAs get sown, some of the advances may not perform and public sector banks may find it difficult to recover the dues by way of interest and principal amount as per the prudential norms prescribed. Such advances are termed as non- performing advances and as per the RBI guidelines they have to be classified under-sub-standard, doubtful and loss advances depending on the period for which the dues have remained unpaid and advances are unsecured. Immediately on expansion of credit, the level of NPAs as percentage to total advances comes down, as there is always a time lag effect in the formation and identification of NPAs after an advance has been released (minimum two quarters). This has already been changed as 90 days w.e.f. 31st March, 2004. As the level of non-performing advances goes on increasing, the public sector banks are inclined to take a safe route of reducing advances and increasing investments. Since investments particularly in Government securities are safe, liquid, fully secured and some times more profitable because of fluctuation in price and interest rates, public sector banks, now-a-days are preferring to investment rather than to advances with a view to avoid formation of NPAs. Further, by investing in Government securities, public sector banks can show better capital adequacy ratio to risk weighted assets as investments are not required to be treated as part of risk weighted assets. From the above discussion, the study finds that there is a strong relationship among these three variables. Thus, the study examines below the relationship and influence of NPAs on advances and investments of different public sector banks

The table 1: highlights the relationship of Gross NPAs with advances and investments of State Bank of India.

Year	Advances (Rs. In Crore)	Gross NPAs (Rs. In Crore)	Investments (Rs. In Crore)
1994-95	48530	NA	41673
1995-96	59826	10561	43819
1996-97	62233	10969	46828
1997-98	74237	11463	54982
1998-99	82360	14063	71287
1999-00	98102	15246	91879
2000-01	113590	15875	122876
2001-02	120806	15486	145142
2002-03	137758	13506	172348
2003-04	157934	12667	185676
Source :	Statistical table relating to	Banking in India.

Graph-1: Position of Advances, Investments and Gross NPAs

As the table 1 shows advances within a period of a decade (i.e. from 1995-96 to 2003-04) has grown up to almost thrice the amount it started from (i.e. from Rs. 59,826 crore in 1995-96 to Rs. 157934 crore in 2003-04) whereas at the same time investments has multiplied to almost five fold from its initial phase (i.e. Rs. 4381 crores in 1995-96 to Rs. 1856 crore in 2003-04). So the study shows that due to putting up more money in investments, there is decrease in growth rate of advances and this happens because of influence of NPAs.

CONCLUSION:

The problem of NPAs in Indian banking system is similar to malignancy in some parts of the body. The ripple effect of NPAs as in the case of cancer, is gradually felt in all parts of the economy viz., savings, investments, production and employments. The high level of NPAs in banks has been a matter of grave concern to the public. Any financial system that works on a net profit of 0.33 percent and a gross NPAs level of over 12 percent cannot sustain for long (Ranjana Kumar, 2000). Any bottleneck in the smooth flow of credit, is caused by the mounting NPAs which in turn, is bound to create adverse repercussions in the economy. The major source of credit risk which arises in public sector banks are due to non- performing assets. In view of this the present chapter first discusses principles and various techniques used for management of credit risk. This study, also makes a simple data analysis to examine the relationship of NPAs with some important variables of public sector banks. The study finds that due to rise of NPAs, the PSBs are now putting more money in investments than that in advances. Similarly, the study also finds that due to constant growth m NPAs the growth rate of spread and Net Profit are severely affected in the SIBs.

ACKNOWLEDGEMENT:

Authors are thankful to SGTB Khalsa College, University of Delhi for cooperating during the research

CONFLICT OF INTEREST:

The authors declare no conflict of interest.

REFERENCES:

1. Aggarwal B.P., Commercial banking in India, Classical Publishing Company, 1981

2. Vakil C.N. Sudhakar V.K., Policies and Perspective of NPAs Reduction in Banks, IBA Bulletin, 1981

3. Ranjan Rajiv and Dhal Sarat Chandra, Non- Performing Loans and Terms of Credit of Public Sector Banks in India : An Empirical Assessment, Reserve Bank of India Occassional Paper, 2003, Vol.24, PP. 81-120

4. Mohan Ram T.T. and Ray C. Subhash, Comparing_ performance of public and private sector banks : A revenue minimization efficiency approach, Economic and Political Weekly, 2004, PP. 1271-1276.

5. Jimenez Gabriel and Sauring Jesus, Collateral, type of lender and relationship banking as determinants of credit risk, Journal of Banking Finance, 2004, PP.2191-2212

6. Instefjord Norvald, Risk and hedging: Do credit derivatives increase bank risk, Journal of Banking and Finance, 2005, PP. 333- 345

7. Bilgrami S.A.R, Growth of public sector banks, Deep and Deep Publication, New Delhi, 1982, P.9.

8. Dangal Thomas and Lehar Alfred, Value-at risk vs. building block regulation in banking, Journal of Financial Intermediation, 2004, PP.96-131

9. Sood R.K., Now-performing assets (NPAs) in public sector banks: an analysis of causes and solution thereof, IBA Bulletin, 2001.

10. Swank T.A. and Root T.H., Bonds in default: is patience a virtue?, Journal of fixed income, 2005

11. Tarapore, S.S., Issues in Financial Sector Reforms, UBSPD, 2000

Received on 16.03.2017 Modified on 24.03.2017

Asian J. Management; 2017; 8(2):337-342.

DOI: 10.5958/2321-5763.2017.00050.6