Banking uses several tools to evaluate the reliability, effectiveness, and stability of its customers. The bank’s reputation could be hurt by even a small imbalance. One method for evaluating the strength and stability of a bank’s finances is to look at its non-performing assets (NPA).
Non-performing assets are loans that have been classified as non-performing by banks and other financial institutions. Interest and principal payments on these loans are overdue by a considerable amount of time. Upon reaching the 90-day mark in India, a loan is considered non-performing. This blog provides a comprehensive explanation of non-performing assets.
What are Non-Performing Assets?
Non-performing assets (NPA) are loans and advances on which the principal is delinquent, and no interest payments have been made for an extended period. In general, a loan becomes an NPA after it has been outstanding for 90 days or more, but some lenders accept loans and advances after a shorter amount of time.
A loan is classified as a non-performing asset when the borrower fails to repay it. As a result, the asset no longer generates income for the lender or bank, since the borrower is not paying interest. In this situation, the loan is deemed to be “in arrears.” There are various types of non-performing assets, depending on how long the assets have been NPAs.
Types of Non-Performing Assets
Lenders usually give borrowers a grace period before labelling an asset as “non-performing.” The lender or bank will then classify the NPA into one of the subsequent subcategories:
1. Standard assets
They are NPAs that have been delinquent for 90 days to 12 months and have a normal risk level.
2. Substandard assets
Substandard assets are a type of non-performing asset (NPA) that refers to loans or advances where the borrower has defaulted on the payment of interest or principal for 12 months or more.
When a loan becomes substandard, it means that it has deteriorated in quality to the point where the lender may no longer consider it a performing asset, and there is a significant risk of default. The lender must classify the loan as substandard and make provisions against the loan to cover the expected loss.
3. Doubtful debts
Non-performing assets in the category of “doubtful debts” have been overdue for at least 18 months. Banks are typically sceptical that the borrower will ever repay the loan in full. This category of NPAs has a significant impact on the bank’s risk profile.
4. Loss assets
These are non-performing assets with a lengthy period of non-payment. With this class, banks are compelled to accept that the loan will never be repaid and are required to record a loss on their balance sheet. The entirety of the loan balance must be written off.
How NPAs Work
Loans or advances made by banks or financial institutions that are classified as non-performing assets (NPAs) are those that the borrower has not repaid the principal and interest on for at least 90 days, meaning that the loan is no longer profitable for the lender.
Non-performing asset (NPA) refers to a debt that has been delinquent and unpaid for a predetermined period.
When the proportion of non-performing assets (NPAs) in a bank’s loan portfolio increases, its income and profitability decrease, its capacity to lend decreases, and the likelihood of loan defaults and write-offs increase.
In response to this issue, the government and Reserve Bank of India have implemented several policies and methods to manage and reduce non-performing assets (NPAs).
Impact of NPAs on banking
NPA is detrimental to all banks. Increasing numbers of nonperforming assets are alarming and raise questions about the banking system. It has significant effects on the work, including the following prominent ones:
1. Financial profitability
It has a direct impact on the bank’s profits. The greater the value of NPA, the lower the institution’s profitability.
2. Liability management
Banks must reduce deposit interest rates to maintain the NPA figure. In addition, it raises lending rates, which has a direct impact on the bank’s operations.
3. Asset contraction
A greater NPA reduces the rate of fund rotation.
4. Capital adequacy
The greater the NPA, the greater the required capital infusion, which increases capital costs.
5. Public confidence
NPA hurts the safety of banks and makes people afraid to do business with them because the bank’s liquidity is at risk.
A greater number of non-performing assets indicates the ineffectiveness of loans and a decline in the income of banks. Therefore, regularly calculating absolute numbers can aid in comprehending the current state of the bank. Two metrics determine the number of non-performing assets.
- GNPA: GNPA is an abbreviation for Gross Non-Performing Asset. This number represents the total amount of NPA for a given quarter or fiscal year. It is calculated by adding the principal amount and all accrued interest.
- NNPA: The abbreviation for Net Non-Performing Asset. The bank’s provision is subtracted from the GNPA. It is the exact amount obtained following the bank’s provisioning.
This ratio shows the total percentage of advances that can’t be repaid. The total amount still owing is represented by amounts advanced.
1. GNPA Ratio: The ratio of gross non-performing assets to gross advances
2. NNPA Ratio: The ratio of Net non-performing assets to net advances
Preventive measures against Non-Performing Assets
The Reserve Bank of India (RBI) has implemented several measures to manage and reduce the levels of non-performing assets (NPAs) in the banking system. The following are some of the measures taken by banks and financial institutions to manage and reduce NPA levels:
1. Loan restructuring
Banks and financial institutions can renegotiate the terms and conditions of a loan to assist the borrower in repaying the debt. This may involve extending the period of repayment or reducing the interest rate.
2. Asset reconstruction companies (ARCs)
ARCs are specialised entities that purchase non-performing assets from banks and other financial institutions. ARCs then attempt to recover the debt owed by the borrower by selling the borrower’s assets or business.
3. Recuperation mechanisms
Banks and other financial institutions use a variety of recovery mechanisms, including debt recovery tribunals (DRTs), recovery agents, the SARFAESI Act, and Lok Adalats, to recoup the debts owed by borrowers.
Banks and other financial institutions may write off the loan if they can’t get the money back from the borrower. This helps to clean up the balance sheets of banks and other financial institutions.
Measures taken by RBI to prevent NPAs
Following are the primary measures taken by the Reserve Bank of India to prevent NPA (NPA in Banking):
- The lending community must adhere to strict deadlines for a resolution plan.
- There must be certain incentives for lenders to agree to ongoing resolution plans.
- There should be initiatives to enhance the current reorganisation process, reorganisation of large values, etc.
- To reach a satisfactory resolution, the cost of future borrowing for non-cooperative borrowers must be increased.
- The asset sales must necessarily receive a more permissive regulatory treatment.
- If a loss is disclosed, the lenders must be permitted to spread the losses over at least two years.
- The use of leveraged buyouts by specialised entities to acquire stressed companies must be permitted. The necessary steps should be taken to improve the efficiency of Asset Reconstruction Companies.
- The private equity/sector-specific companies should be assisted so that they can play a very active role in the stressed asset market.
Non-Performing Assets (NPAs) remain a significant challenge for banks and financial institutions worldwide. NPAs can arise due to various factors such as economic downturns, poor lending practices, and borrower defaults. They have severe consequences for banks, including loss of revenue, increased regulatory scrutiny, and reputational damage. Addressing NPAs requires a combination of measures, such as improving risk management practices, restructuring loans, and pursuing legal remedies to recover bad debts.
It is also essential to recognise the broader implications of NPAs for the economy as a whole. High levels of NPAs can lead to a credit crunch, reducing lending and investment, and slowing economic growth. Thus, policymakers need to implement reforms that strengthen the financial sector’s resilience and reduce the risk of NPAs. This may involve measures such as improving governance and accountability, enhancing transparency, and promoting financial inclusion.
In summary, tackling the NPA problem requires a coordinated effort from banks, regulators, and policymakers to implement effective solutions that address the root causes of the problem. By doing so, we can ensure a stable and resilient financial system that supports economic growth and development.
1. What is a Non-Performing Asset?
Ans: An NPA is a loan or advance made by a bank or financial institution that has ceased to generate income for the lender because the borrower hasn’t repaid the principal and interest for at least 90 days (about 3 months).
2. What are Non-Performing Assets in corporate accounting?
Ans: Non-performing assets (NPAs) in corporate accounting refer to loans, advances, or assets that have stopped generating income or have ceased to perform due to the borrower’s failure to repay the principal or interest on a loan, resulting in a default. NPAs are a significant concern for banks and financial institutions as they affect their profitability, solvency, and reputation. Companies must classify and disclose their NPAs accurately and have robust credit risk management systems in place to monitor and mitigate the risk of NPAs.
3. What can I do to settle my NPA loan?
Ans: A one-time settlement (OTS) offers you the chance to finally pay off your NPA loan.
4. What are the different types of Non-Performing Assets?
Ans: Lenders usually give borrowers a grace period before labelling an asset as “non-performing.” The lender or bank will then classify the NPA into one of the subsequent subcategories:
- Standard Assets
- Substandard Assets
- Doubtful Debts
- Loss Assets