In the wake of deteriorating asset quality in the banking system, which is hovering at record highs, the Reserve Bank of India on Thursday asked banks to strengthen their due diligence and improve the loan recovery process.

“Banks need to not only follow the various measures put in place by the RBI and the government effectively for resolution and recovery of bad loans but also to strengthen their due diligence, credit appraisal and post sanction loan monitoring systems to minimise and mitigate the problems of increasing non-performing assets (NPAs),” the RBI said in its ‘Trends and progress of banking report 2012-13’.

Gross NPAs as per cent of gross advances for scheduled commercial banks stood at 3.6 per cent as at March 2013 as against 3.1 per cent previous fiscal, the RBI said.

Net NPAs as per cent of net advances for banks stood at 1.7 per cent in FY13 as against 1.3 per cent previous year.

The asset quality of the banking system deteriorated significantly during 2012-13 and there was an increase in the total stressed assets in the banking system, that is NPAs plus restructured assets, the RBI said.

As the end of March 2013, the gross NPAs stood Rs. 1,94,000 crore, according to the RBI. Public sector banks had highest amount of bad loans at Rs. 1,65,000 crore followed by private sector banks at Rs. 21,000 crore and foreign bank at Rs. 7,900 crore.

The apex bank also called for better legal system in place to help bank recover public funds from defaulters.

“There is an urgent need for accelerating the working of debt recovery tribunals and asset reconstruction companies,” RBI said.

The deterioration in asset quality was most perceptible for the SBI group with its NPA ratio reaching a high of 5 per cent at end March 2013.

“Deterioration in asset quality in 2012-13 was primarily on account of the non-priority sector,” RBI said.

It further said the banks need to improve the effectiveness of the recovery system.

Recovery should be focused on efficiency and fairness- preserving the value of the underlying assets and jobs where possible, even while redeploying unviable assets to new uses and compensating employees fairly, the central bank report said.

This should be done while ensuring that contractual priorities are met.

It is also necessary to collect credit data and examine large common exposures across banks. This will enable the creation of a central repository on large credits, which can be shared with the banks, the RBI said.

“This in turn will enable banks to be aware of building leverage and common exposures. This also underscores the need for expediting the setting up of an enhanced resolution structure for financial firms. Going forward, these issues will engage priority attention of Reserve Bank,” the central bank said.

Meanwhile, the report said banks overall growth slowed for the second consecutive year in FY13.

“Both balance sheet and off-balance sheet operations of Indian banks slowed down in 2012-13 for the second consecutive year,” the report said.

There was as overall slowdown in credit growth though retail credit remained buoyant.

In FY13, banks non food credit grew 13.5 per cent as against 17 per cent in FY12.