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Banking Sector's Output in National Accounts: Measurement Issues

The revision of the system of national accounts of 1993, due by 2007-08, is expected to bring about several conceptual and computational changes. The impact of such changes on the financial sector's contribution to the gross domestic product seems to be quite significant. These changes are conceptually intricate and their implementation would also be challenging. This paper presents a prospective view of the ensuing changes as debated in international forums. In addition, two key issues, namely, the valuation of GDP of the banking sector at constant prices and the treatment of non-performing loans of banks in national accounts are discussed. The paper also highlights that the adjustment of financial intermediation services, indirectly measured, for the incidence of non-performing loans will have significant effects on the estimated macroeconomic aggregates on financial activities.

Banking Sector’s Output in National Accounts: Measurement Issues

The revision of the system of national accounts of 1993, due by 2007-08, is expected to bring about several conceptual and computational changes. The impact of such changes on the financial sector’s contribution to the gross domestic product seems to be quite significant. These changes are conceptually intricate and their implementation would also be challenging. This paper presents a prospective view of the ensuing changes as debated in international forums. In addition, two key issues, namely, the valuation of GDP of the banking sector at constant prices and the treatment of non-performing loans of banks in national accounts are discussed. The paper also highlights that the adjustment of financial intermediation services, indirectly measured, for the incidence of non-performing loans will have significant effects on the estimated macroeconomic aggregates on financial activities.


I Introduction

t is quite well known that among the various service sector industries, the banking and financial sector is one in which output is notoriously difficult to measure. In fact, this is true of many types of services, where output is not measured directly, and real values have to be imputed. Issues in the measurement of the output of banks as production units and in the context of national accounts have been debated for a long time. Conceptually, two approaches, viz, the national accounts approach to banking output and the bank production function approach, are somewhat different. The national accounts approach does not count the provision of finance to bank borrowers in itself as an output of the banking industry, which is in sharp contrast to the bank production function approach.

It is rightly acknowledged that in the national accounts approach to banking, interest cannot be treated as output of banks. Thus, in order to obtain some output measure, a convention was adopted that the interest rate spread between loan and depositor rates could be used in national accounts as the output of banks, so long as it was interpreted as something that was not interest. Interest, in national accounts, is primarily a transfer, or a receipt of property income, involving owners of financial claims and others. Interest is not regarded as a payment for a productive service. If interest is not a payment for a productive service, it cannot be payment for an output of banks. “The concept of production used in the system of national accounts (SNA) requires some activity, or process, to take place involving labour and capital assets in which inputs are transformed into outputs and in which factor incomes are generated. Lending is not an activity of this kind” [Hill 1996, p 2]. Therefore, by definition, the provision of finance is not an output of banks in the SNA. On the same reasoning, deposits do not themselves provide “productive” inputs to banks in the SNA view, again contrary to the treatment of bank financial inputs in banking production function studies.

In the parlance of the system of national accounts 1993 (SNA93), the output of the intermediation services provided by financial corporations including banks is measured using the concept of FISIM, i e, financial intermediation services indirectly measured. SNA93 broadly follows the user cost of money approach for estimating the output of the financial services, which is often confined to the traditional loan and deposit services provided by the banks. In the perspective of the present-day coverage and spread of the financial sector, the focus in SNA93 appears somewhat narrow, confined to intermediation activity alone rather than encompassing the entire gamut of financial services. In terms of institutional coverage also, activities of some financial intermediaries like mutual funds are not explicitly covered.

There have been many developments and significant structural changes in the working of financial corporations over the past decade or so, including widening of the nature of services provided, changes in the composition/importance of different portfolios (and hence sources of income), new channels and institutions for providing financial services and increase in intra-sectoral transactions. In recognition of these developments and the consequent need for bringing about improvements in capturing the financial sector’s contribution to GDP, several issues pertaining to measurement of output of financial services, non-life insurance services, output of central banks, valuation of non-performing loans, retained earnings of mutual funds, insurance companies, and pension funds, etc, have been included in the process of revision of the SNA93 under the aegis of the United Nations Statistics Commission, which is currently under way. A detailed list of issues discussed in the Workshop on SNA93, Bangkok during April 19-22, 2005 is presented in Appendix 1.

In the Indian context, the methodological framework adopted for estimating the contribution of the banking and financial sector to GDP in the national accounts statistics (NAS) broadly followed the general guidelines prescribed in SNA93. By and large, the approach has been followed in the 1993-94 series and also in the recently revised series of NAS with base

Economic and Political Weekly September 15, 2007

1999-2000 [CSO 2006]. However, at the time of implementation, several assumptions are made due to data limitations, structure of the financial system and lack of clarity of some conceptual issues. Over the years, the coverage has widened, data availability has improved and attempts are being made to minimise the data gaps. Kulshreshtha and Singh (1999) provide an account of these issues for the entire services sector. Nevertheless, there is still a lot of scope for further improvement.

In this article, an attempt is being made to flag some of these issues. To start with, we provide a snapshot of the conceptual issues concerning measurement of output of banks and other financial corporations, which have been taken up in the SNA93 revision. The second issue relates to the estimation methodology for obtaining the GDP of the banking and insurance sector at constant prices in the Indian context. We present a natural approach for estimation of banking sector output at current as well as at constant prices. It is understood from the deliberations of the March 2006 seminar that a similar approach has since been adopted in the latest NAS estimates by the CSO. The third issue relates to the treatment of non-performing loans in NAS. The unprecedented financial crisis that affected several countries in the late 1990s has led to renewed interest in the issue of how macroeconomic statistics should account for non-performing loans. Issues relating to nonperforming loans may affect all sectors. The most serious impact, however, is on financial institutions such as commercial banks, which tend to own large loan portfolios. Non-performing loans are, in general, not explicitly recognised in the SNA93. In addition, “provisions for bad debts are treated as bookkeeping entries that are internal to the enterprise and do not appear anywhere in the System” [SNA93, para 10.140]. The International Monetary Fund indicated in 2001 that there is a need for adjustment for non-performing loans in macroeconomic statistics and international manuals in line with the recommended best practices [Bloem and Gorter 2001]. In this context, SNA93 seems to show some departures from international best practices recommended by the Institute of International Finance (IIF), the International Accounting Standards Board (IASB) and the Basel Committee on Banking Supervision (BCBS).

The paper is organised as follows. In Section II, a brief overview is provided of the developments in the SNA revision process on the issues concerning measurement of GDP from the banking and financial sector. Section III presents the current practice and relevant issues for estimating the GDP of the banking and insurance sector in India. The role of nonperforming loans and their plausible treatment in GDP estimation is discussed in Section IV. Empirical illustrations of the approaches suggested in the paper are provided in Section V. Section VI concludes the paper.

II GDP from Financial Sector: SNA Revision

An OECD task force examined these issues as part of the SNA revision process and framed recommendations for consideration of the advisory expert group (AEG) for SNA revision. In a progress report of the task force, Schereyer and Stauffer (2002) examined the nature of the activities of financial corporations as defined in SNA93. Financial corporations were defined in SNA93 as “…all resident corporations or quasi-corporations principally engaged in financial intermediation or in auxiliary financial activities which are closely related to financial intermediation”.

Further, the activity of financial intermediation was defined as “...a productive activity in which an institutional unit incurs liabilities on its own account or for the purpose of acquiring financial assets by engaging in financial transactions in the market. The role of financial intermediaries is to channel funds from lenders to borrowers by intermediating between them. They collect funds from lenders and transform, or repackage, them in ways that suit the borrowers. They obtain funds by incurring liabilities on their own account, not only by taking deposits but also by issuing bills, bonds or other securities. They use these funds to acquire financial assets, principally by making advances or loans to others but also by purchasing bills, bonds, or other securities. A financial intermediary does not simply act as an agent for other institutional units but places itself at risk by incurring liabilities on its own account.”

The task force relabelled the activities of “risk taking” and “repackaging” as “risk management” and “liquidity transformation” respectively and sought to define financial corporations as those who are engaged in financial services, which is produced as a result of “risk management”, “liquidity transformation” and auxiliary financial activities. It argued that “intermediation” alone does not capture the full range of services provided by financial corporations and listed a number of other services, including “monitoring services”, “convenience services”, “liquidity provision services”, “risk assumption services”, “financial information services”, “underwriting services” and “inventory, trading and market making services”.

The main recommendations of the task force on the definition and measurement of the production of financial services of these entities, as reported in Nordin (2005) for the January 2006 meeting of the AEG, can be summarised as follows.

  • (1) The definition of financial corporation should be based on the nature of (financial) services instead of their activity and should include “risk management” and “liquidity transformation” along with financial intermediation.
  • (2) For the computation of FISIM based on the difference between the property income receivable and total interest payable of the financial corporations, the interest rates should be ad justed with respect to a reference rate, i e, FISIM may be calculated based on the formula: (RL – R) x YL – (RD – R)
  • rr× YD, where Rr is a risk free reference rate that has no service element in it and that reflects the maturity structure of the financial assets, and RL, YL and RD, YD are respectively the interest rate and size of the loan and deposit portfolio of banks. This is a departure from SNA93 and more in line with the European System of Accounts, as updated in 1995 (abbreviated as ESA95). After rearranging the above formula, one can get FISIM = RL × YL – RD x YD + (YD – YL) × R. As, in

    rgeneral, YD > YL, the proposed formula for FISIM should

    roughly raise the size of FISIM by (YD – YL) × R, as com

    rpared to the FISIM derived from existing method. In other words, the new method is expected to correct the under estimation of FISIM to a large extent.

  • (3) Moreover, the computation also includes property income receivable from investment of “own funds”, which was excluded in SNA93 on the ground that such income did not arise from financial intermediation.
  • (4) Expected holding gains and losses should presently not
  • Economic and Political Weekly September 15, 2007 enter into the measurement of financial services output.

  • (5) With respect to market making and trading services, the measurement of the implicitly priced elements – margins on foreign exchange and buying and selling of all securities by all financial corporations – should be made regardless of the purpose for which the securities and other instruments are being bought or sold.
  • (6) In the absence of direct deflators for the output of implicitly priced financial services at current prices, the rate of change of the volume indicator should be derived using the rate of change of stocks of loans and deposits deflated by a general price index (e g, the GDP deflator) or using a direct output indicator method.
  • It is to be noted that the above prescriptions are under the consideration of the AEG and final decisions on them are yet to be taken. Besides, while a broad revised framework has been suggested, the details of computation for different types of financial corporations are yet to be worked out, which would entail considerable work and would have to be examined before considering implementation. Further, some issues in the pricing of financial services arising from efficiency gains and product quality changes are yet to be addressed. Nevertheless, the above suggestions would have considerable bearing on the computation of GDP from the banking and financial sector in the Indian context and revision of methodology in due course.

    III GDP at Constant Prices: Current Practice and Issues

    Against the above background, some interim suggestions for computation of GDP from the banking sector in India are presented in this section. Presently, gross value added (GVA) for the banking and insurance sector in India is prepared and disseminated separately for (1) commercial banks, (2) the banking department of the Reserve Bank of India, (3) post office savings bank, (4) non-banking financial institutions (organised and unorganised), (5) cooperative credit societies,

    (6) employees’ provident fund organisations, and (7) insurance (life and non-life). The GDP from this sector is estimated by the income method, using readily available source material for each of the sub-sectors. The GVA of banking and financial enterprises is based on the concept of imputed service charge (income), which is equivalent to interest and dividend receipts, net of interest paid to depositors. The output of the financial sector is partly treated as intermediate consumption of industries and partly as the final consumption of government and households. The estimates at current prices in respect of commercial banks are obtained from the income, expenditure and appropriations data available in Statistical Tables Relating to Banks in India, an annual publication brought out by the Reserve Bank of India. The estimates at constant prices of GDP of the banking sector in the present NAS series are prepared by moving forward the base year estimate with a quantum index derived using the aggregate deposits deflated by the wholesale price index (WPI) of all commodities [Kulshreshtha and Singh 1999]. Indeed, a similar approach is followed for each of the subsectors under banking and insurance. In a practical sense, the real growth of the sector merely exhibits the real growth of the quantum index. It is, therefore, envisaged that such estimates compared over a period would not provide a proper measure of the overall increase in the financial/banking services in real terms. The basic idea of transforming the series to constant prices is to eliminate the effect of price change, or in other words recompute the series at given prices of the base year. However, carrying forward the base year value using a quantum index may not be appropriate.1 In order to address the issue, we have suggested the following alternative method.

    IV Non-performing Loans and National Income

    Financial services produced and provided to debtors have some inherent additional price component. The average price charge on debtors is higher than the effective price prevailing in the market on account of the incidence of non-performing loans. As financial intermediaries expect such situations to occur, they include in their interest rate a risk premium covering defaults. This risk is finally passed on to the customers and thus customers pay a higher interest rate than they would otherwise. As a result, in national accounts the price charged for loan services is in general overvalued. Therefore, there is a need for adjustment to estimate FISIM in order to avoid the implicit overvaluation of output, value added and operating surplus of financial intermediaries. The adjustment should eliminate the excess spread charged by them when taking into account the risk of losses due to defaults of borrowers. Ideally, such adjustments should cover not only the defaulted loans but also the interest not paid, since both of them are supposed to be taken into account by financial intermediaries when fixing the spread between the interest rate charged and paid by the banks. The adjustment will also affect the series at constant prices, since the base year spread will change. Against this background, we propose to use the provision made by the banks as an approximation to the adjustment that should be made to FISIM. We are assuming that such adjustment would eliminate the risk premium incorporated in the interest rate charged by banks when trying to cover defaults by borrowers. Mandler et al (2004) also followed similar approach. The classification of non-performing loans and the provision thereof of Indian banks are based on the uniform guidelines issued by the Reserve Bank of India. A brief description of the classification of non-performing loans and the provisioning norm is presented in Appendix 2.

    V Empirical Analysis

    The banking sector plays an increasingly important role in gross domestic product in India. During the past decade, its share (in real terms) has gone up from 4.64 per cent in 1993-94 to 5.97 per cent in 2003-04. However, the growth of this sector has been highly volatile; ranging from 15.84 per cent in 1999-2000 to (-)1.41 per cent in 2000-01. In recent years, its growth has been around 7-8 per cent (Figure 1). At current prices, the growth rate of the banking sector during 2002-03 and 2003-04 was more than 20 per cent. When the contribution of commercial banks (at constant prices) is examined in isolation, it is observed that GDP from them not only grew at a healthy rate of 12.30 per cent in 1993-94 to

    9.98 per cent in 2003-04, but also recorded low volatility. In other words, the high volatility of the banking sector growth in GDP is mainly because of the other components like

    Economic and Political Weekly September 15, 2007

    Figure 1: Growth Rate and Contribution of Banks in GDP at 1993-94 Prices

    19 16 13 10 7 4 1 -2

    Contribution Growth rate


    non-banking financial institutions, post office savings banks, and cooperative credit societies.

    As an empirical illustration, the contribution of the commercial banking sector to GDP at constant prices using the proposed method is presented in Table 1. This approach indicates that the methodology adopted in the earlier series of NAS was likely to underestimate the GDP of banks. For some years, under estimation could be significantly large. For example, in 2003-04, the change in valuation in real terms could increase the GDP to the tune of Rs 7,827 crore. In terms of growth, the revised method results a much higher growth in recent years.

    Finally, to examine the impact of non-performing loans (NPLs) on GDP of banks, a simple exercise is worked out. It may be seen from Table 2 that the level of NPLs of commercial banks is quite sizeable (Rs 57,545 crore in 2004-05 as against Rs 60,841 crore in 1999-2000). However, recent years have witnessed a substantial drop in NPLs. The ratio of net NPL to net advances fell from 12.79 per cent in 1999-2000 to

  • 4.91 per cent. On the other hand, the growth of NPL fell from
  • 5.13 per cent in 2000-01 to (-)11.33 per cent in 2004-05.
  • As mentioned earlier, the provisions made by banks for bad debts are taken as an approximation to the adjustment. The computations are presented in Table 3. Adjustment is made using two alternative methods, including the method suggested in this paper. The table shows that although the provisions for bad debts amount to a relatively small share of total loans (3.45 per cent in 2003-04) advanced by the commercial banks, they have grown considerably during the last decade, creating an important impact on both absolute values and percentage changes over time. For example, during 2003-04, the GDP of banks at constant prices at Rs 39,602 crore should get reduced to Rs 29,982 crore (under

    Table 1: GDP of Commercial Banks (Proposed Method): 1993-94 to 2003-04 (Rs crore)

    Year At Current At Growth at WPI Estimate Differ- Growth Prices Constant Constant Using ence (Per Cent) Prices Prices Proposed (Per Cent) Method

    (1) (2) (3) (4) (5) (6) (7) (8)

    1993-94 14291 14291 100.0 14291 0 1994-95 18594 16049 12.30 112.5 16528 479 15.65 1995-96 25540 17078 6.41 121.6 21003 3925 27.08 1996-97 27669 18421 7.86 127.2 21752 3331 3.57 1997-98 32125 20736 12.57 132.8 24191 3455 11.21 1998-99 34902 23073 11.27 140.7 24806 1733 2.54 1999-00 40485 25977 12.59 145.3 27863 1886 12.32 2000-01 46966 28557 9.93 155.7 30164 1607 8.26 2001-02 55611 31544 10.46 161.3 34477 2933 14.30 2002-03 69222 36009 14.15 166.9 41475 5466 20.30 2003-04 83427 39602 9.98 175.9 47429 7827 14.35

    the proposed method) if the impact of NPLs is taken into consideration. In other words, around one-fourth of the total value of GDP of the banking sector of the current series could be contributed by the prevalence of NPLs. Whatever method is adopted, the relatively small magni tude of provisions for bad debts (as against the large loan portfolio of banks) seems to have a large impact on the GDP of the banking sector.

    The issue of NPL of banks is generally addressed by pro per credit assessment and risk management mechanisms, avoiding adverse selection and not compromising on asset quality. Besides NPL recovery by banks, the setting up of asset reconstruction companies (ARCs) in 2002 has provided banks and financial institutions with another weapon to tackle the problem of nonperforming assets (NPAs). Under this new system, only the core NPAs of banks over a certain size are taken over in exchange for NPLs swap bonds representing the realisable value of the assets transferred. This arrangement is likely to benefit the banks as they will hold interest bearing marketable bonds in their balance sheets instead of making provisions for NPLs. Therefore, NPLs subsequently recovered by the banks themselves or through ARCs will lead to a reduction in NPL provisioning and thereby increase the GDP of the banking sector.

    VI Conclusion

    The current ongoing revision of SNA93 envisages a sea change in the treatment of the financial sector’s contribution

    Table 2: Non-performing Loans of Commercial Banks in India: 1999-00 to 2004-05 (Rs crore)

    Year Non-Performing Growth Advances Growth of Net NPL/Net
    Loans of NPLs Advances Advances
    (Per Cent) (Per Cent) (Per Cent)
    (1) (2) (3) (4) (5) (6)
    1999-00 60841 475758 12.79
    2000-01 63963 5.13 558679 17.43 11.45
    2001-02 70954 10.93 680869 21.87 10.42
    2002-03 70314 -0.90 776508 14.05 9.06
    2003-04 64897 -7.70 902026 16.16 7.19
    2004-05 57545 -11.33 1171210 29.84 4.91

    Source: Statistical Tables Relating to Banks in India, 2004-05, RBI.

    Table 3: Impact of Non-performing Loans in GDP of Commercial Banks: 1999-00 to 2003-04 (Rs crore)

    Year GDP at Provi- GDP at Differ- GDP at GDP at Constant Differ-Current sions Current ence Constant Prices Ad- ence Prices Prices Prices justed for Provision Adjusted Using for Pro-Proposed Existing visions Methods Methods

    (1) (2) (3) (4) (5)=(2)-(4) (6) (7) (8) (9)= (6)-(7)

    1993-94 14291 9115 5176 9115 14291 5176 5176 9115 1994-95 18594 5681 12913 5681 16049 11478 5813 10873 1995-96 25540 9454 16086 9454 17078 13229 6186 11902 1996-97 27669 8443 19226 8443 18421 15115 6672 13245 1997-98 32125 8246 23879 8246 20736 17981 7511 15560 1998-99 34902 9414 25488 9414 23073 18115 8357 17897 1999-00 40485 11213 29272 11213 25977 20146 9409 20801 2000-01 46966 13376 33590 13376 28557 21574 10343 23381 2001-02 55611 18405 37206 18405 31544 23066 11425 26368 2002-03 69222 23700 45522 23700 36009 27275 13043 30833 2003-04 83427 30689 52738 30689 39602 29982 14344 34426

    Economic and Political Weekly September 15, 2007 to national accounts statistics. Such changes are conceptually intricate and their implementation would also be challenging. Against this background, in this paper, an attempt is made to examine the existing methodology followed for estimating the GDP of the banking sector. In addition to the questions relating to the revision of SNA93, two key issues are identified. One relates to the valuation of GDP of the banking sector at constant prices and the other relates to the treatment of NPLs of banks in national accounts. For valuation, we have suggested an alternative method and for NPLs, we have flagged the issue based on literature available in international forums. We have shown by a simple exercise that the current approach of valuation could lead to significant underestimation of the contribution to GDP of the banking sector. In addition, we have shown that the adjustment of FISIM in order to eliminate the risk premium from interest rates charged by financial intermediaries may have significant effects on the estimated macroeconomic aggregates on financial activities. Such adjustments are particularly important in periods of economic recession. Therefore, it is necessary to capture appropriately the impact of NPLs so as to avoid giving wrong signals from the national accounts on the level and characteristics of financial activities.

    Appendix 1 List of Issues Discussed for SNA93 Review

    1 Repurchase agreements 2 Employer retirement pension schemes 3 Employee stock options 4 Valuation of non-performing loans, loans and deposits 4a Non-performing loans 4b Valuation of loans and deposits; write-off and interest accrual on

    impaired loans 5 Non-life insurance services 6 Financial services 6a Financial services 6b Allocation of output of central banks 7 Taxes on holding gains 8 Interest under high inflation 9 Research and development

    10 Patented entities 11 Originals and copies 12 Databases 13 Other intangible fixed assets – new information and specialised

    knowledge 14 Cost of ownership transfers 15 Cost of capital services: production account 16 Capital services from government owned assets 17 Mineral exploration 18 Right to use/exploit non-produced resources between residents and

    non-residents 19 Military expenditures 20 Land 21 Contracts and leases of assets 22 Goodwill and other non-produced assets 23 Obsolescence and depreciation 24 Build-own-operate-transfer (BOOT) schemes 25 Units 25a Ancillary units 25b Institutional units 26 Cultivated assets 27 Classification and terminology on assets 28 Amortisation of tangible and intangible non-produced assets 29 Assets boundary for non-produced intangible assets 30 Definition of economic assets 31 Valuation of water 32 Informal sector

    33 Illegal and underground activities 34 Super dividend, capital injections and reinvested earnings (government transactions with public corporations [earning and funding]) 35 Tax revenues, uncollectable taxes and tax credits (recording of tax

    es) 36 Private/public/government sector delineation (sectorisation) 37 Activation of guarantees (contingent assets) and constructive obliga

    tions 38 Transaction concept 38a Change of (economic) ownership (as term) 38b Assets, liabilities and personal effects of individuals changing residence

    (‘migrant transfers’) 39 Residence 39a Meaning of national economy 39b Predominant centre of economic interest (as term) 39c Clarification of non-permanent workers and entities with little or no

    physical presence and/or production 40 Goods sent abroad for processing 41 Merchanting 42 Retained earnings of mutual funds, insurance companies, and pension

    funds 43 Interest and related issues 43a Treatment of index-linked debt instruments 43b Interest at concessional rates 43c Fees payable on securities lending and gold loans 44 Financial asset classifications

    Appendix 2 Non-performing Assets

    As per the latest RBI guidelines (master circular dated July 1, 2005), an asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. In particular, a non-performing asset (NPA) is a loan or an advance where:

  • (1) interest and/or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan,
  • (2) the account remains ‘out of order’ in respect of an overdraft/cash credit (OD/CC),2,
  • (3) the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,3,
  • (4) in the case of a loan granted for short duration crops, the instalment of principal or interest thereon remains overdue for two crop seasons, or
  • (5) in the case of a loan granted for long duration crops, the instalment of principal or interest thereon remains overdue for one crop season.
  • Banks classify an account as NPA only if the interest charged during any quarter is not paid fully within 90 days from the end of the quarter.

    Provisioning Norms of Non-performing Assets

    The primary responsibility for making adequate provisions for any diminution in the value of loan assets is that of the bank managements and the statutory auditors. The assessment made by the inspecting officer of the RBI is furnished to the bank to assist the bank management and the statutory auditors in taking a decision in regard to making adequate and necessary provisions in terms of prudential guidelines.

    In conformity with the prudential norms, provisions should be made on the non-performing assets on the basis of classification of assets against sub-standard assets, doubtful assets and loss assets. Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 per cent of the outstanding should be provided for. For doubtful assets, 100 per cent of the extent to which the advance is not covered by the realisable value of the security to which the bank has valid recourse and the realisable value are estimated on a realistic basis. In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 20 per cent to 100 per cent of the secured portion depending upon the period for which the asset has remained doubtful. For sub-standard assets, a general provision of 10 per cent on total outstanding should be made without making any allowance for ECGC guarantee cover and securities available. The “unsecured exposures” which are identified as “sub-standard” would attract additional provision of 10 per cent, i e, a total of 20 per cent on the outstanding balance. The provisioning requirement for unsecured “doubtful” assets is 100 per cent. The banks

    Economic and Political Weekly September 15, 2007

    should make a general provision of a minimum of 0.25 per cent on standard assets on global loan portfolio basis.




    [This paper represents the authors’ personal views and does not reflect the opinions of the organisation with which they are associated.]

    1 Traditionally, the issue of conversion to constant prices of output of the financial sector was solved by developing certain production or price indicators. For example, till the end of 1980s, the US Bureau of Economic Analysis (BEA) used one such indicator for conversion of gross product originating in the banking sector from current prices to constant prices. Output at constant prices was obtained by extrapolating the benchmark value by a factor based on the number of persons engaged in production, assuming no labour productivity growth in banking [see Srimany and Bhattacharya 1998, for a discussion]. For some of the latest developments on the measurement of banking service price, one may refer to Barman and Samanta (2004).

    2 An account should be treated as “out of order” if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days as on the date of the balance sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as “out of order”.

    3 Any amount due to the bank under any credit facility is “overdue” if it is not paid on the due date fixed by the bank.


    Barman, R B and G P Samanta (2004): ‘Banking Services Price Index: an Exploratory Analysis for India’, IFC Bulletin 19, pp 110-124

    Bloem, A M and Cornelis N Gorter (2001): ‘The Macroeconomic Statistical Treatment of Non-performing Loans’, Discussion Paper, Statistics Department, International Monetary Fund.

    CSO (Central Statistical Organisation) (2006): ‘National Accounts Statistics 1999-2000 Brochure’ (2006), Central Statistical Organisation, Department of Statistics, Ministry of Planning, Government of India.

    Hill, P (1996): ‘The Services of Financial Intermediaries, of FISIM Revisited’, Paper Presented at Brookings Institution Workshop on Measuring Banking Output.

    Kulshreshtha, A C and Gulab Singh (1999): ‘Services Sector in National Accounts: Methodology, Data Quality, Gaps and Possibilities of Improvement’, The Journal of income and Wealth, Vol 21, No 2, July, pp 133-154.

    Mandler, Pablo, Aharon Blekh and Daniel Finzi (2004): ‘Non-performing Loans, Interest Arrears and FISIM Estimates’, Working Paper No 3, Conference of European Statisticians, Geneva, April 27.

    Nordin, Anders (2005): ‘The Production of Financial Corporations and Price/Volume Measurement of Financial Services and Non-Life Insurance Services’, OECD.

    Schereyer, P and P Stauffer (2002): ‘Measuring the Production of Financial Corporations, Progress Report’ by the OECD Task Force on Financial Services (Banking Services) in National Accounts.

    SNA93: 1993 System of National Accounts, United Nations, at http://

    Srimany, A K and K Bhattacharya (1998): ‘Measures for Financial Services: A Review with Special Reference to Banking in India’, Reserve Bank of India Occasional Papers, 19, pp 1-38.

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    A Microfinance Institution with a Difference –Aloysius P Fernandez
    Microfinance for Poverty Reduction: The Kalanjiam Way –M P Vasimalai, K Narender
    Banking and Financial Policy: An Independent View –Rajaram Dasgupta, M Thomas Paul
    How Do We Assess Monetary Policy Stance?
    Characterisation of a Narrative Monetary Measure for India –Indranil Bhattacharyya, Partha Ray
    Indian Banks’ Diminishing Appetite for Government Securities: A Change of Diet? –Amadou Sy
    Indian Macroeconomic Concerns: Corrective Steps towards Sound Banking –Rupa Rege Nitsure

    For copies write to: Circulation Manager, Economic and Political Weekly, Hitkari House, 6th Floor, 284, Shahid Bhagatsingh Road, Mumbai 400 001.

    Economic and Political Weekly September 15, 2007

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