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What is Non-Performing Asset (NPA) in Banking and What is its Impact?
11 July 2022
According to the Reserve Bank of India (RBI), any asset that stops generating revenue flow for the bank is considered a non-performing asset (NPA). As per RBIs definition, any loan or advance over 90 days past due will be considered a non-performing asset (NPA). As a result, any advances or loans that are in default or in arrears are categorised as Non-Performing Assets (NPA).
Non-Performing Asset (NPA) Meaning
A Non-Performing Asset or NPA is an advance or a loan where the payment of the principal amount and interest is 90 days past due.
“An asset becomes non-performing when it stops generating income for the bank,” states RBI. Assets have been considered as any useful resource that may be sold and transformed into cash. They either bring in money or provide some other kind of advantage to people, businesses, and governments.
A loan is considered an asset for banks since banks earn profits through the interest paid by borrowers. When a borrower is unable to repay the money or defaults on a loan, the asset becomes non-performing for the bank since the revenue channel for that particular loan stops.
How Non-Performing Assets (NPAs) Work?
Non-performing assets are recorded on a bank’s or other financial institution’s balance sheet. The lender asks the borrower to liquidate any assets pledged as part of the loan agreement after a prolonged period of non-payment. In the absence of pledging of assets, the lender may write off the asset as a bad debt and subsequently sell it at a loss to a collection company.
Debt is usually categorised as non-performing when loan payments are not made for 90 days. While 90 days is the industry standard period, the length of time elapsed may be shorter or longer based on the terms and conditions of each loan. During the loan’s term and maturity, a loan may be labelled as a non-performing asset.
Gross NPA and Net NPA are the two different types of NPA. These are described in terms of their possessions. To fully understand the several types of NPA, let’s study about five categories of assets in the banking sector: –
1. Standard Assets
Standard Assets are considered to be a low risk under bank regulations. Because they can provide profits for the banks, they are often referred to as performing assets.
2. Substandard Assets
These are assets that have been non-performing for less than or equal to 12 months.
3. Doubtful NPA
An NPA that has been in the Substandard NPA category for 12 months or less.
4. Loss Assets
Loss Assets arise when the NPA has been acknowledged as losses suffered by the bank or financial institution (RBI). When an asset is “uncollectible” or so unworthy that it cannot be maintained as a bankable asset, it is referred to as a loss asset. Since the item has not been completely or partially written off, some recoverable value may still be left in it.
Why Do Banks Worry About an Account Becoming an NPA?
Banks are concerned about their accounts becoming NPAs for various reasons:
Revenue Loss: When an account becomes a stressed account (NPA), banks are no longer allowed to charge interest
Reputation: Increased NPAs hurt the bank’s brand image and reputation
Higher Provisions: If a bank account becomes an NPA, RBI applies special rules forcing banks to increase provisions at a higher rate
Stock Market Crash: If the bank is registered with NPAs, its stock market prices may drop.
Impacts of NPA in Banking
The biggest issue in today’s banks is the increasing number of NPAs. Investor, depositor, and stakeholder confidence also takes a hit if a financial institution has high NPAs.
Non-profitability Due to NPA: Non-Performing Assets affect the bank’s profit and increase its losses. Additionally, Banks are bound to provide extra provisions of 25-30% for NPAs, which reduces the bank’s profits.
Management of Liabilities: High non-performing assets could lead a bank to cut deposit interest rates, and advances are likely to have higher interest rates. The banking industry is affected by this challenging scenario.
Confidence of Shareholders: Shareholders need to know that their money is secure. They also care about the growth of investment and market capitalisation.
Impact of NPA on Borrowers
Borrowers whose loan defaults lead to an NPA are impacted in the following ways:
NPAs lower a borrower’s CIBIL to a great extent and thus bring down their creditworthiness.
It impacts borrowers and entities operating under them. This implies that subsidiary companies can face obstacles owing to NPA.
It can also impact borrowers’ goodwill.
Banks consider such borrowers’ accounts with NPA as red flags. Therefore, they will be apprehensive about sanctioning loans to these borrowers. This would make getting a loan in the future extremely difficult.
How to Calculate NPAs via Gross NPA and Net NPA?
Gross NPA refers to the sum of all the unpaid loans accounted to a financial institution. It’s calculated via: Gross NPA = (A1 + A2 + A3 ……………………. + An)/Gross Advances, where A1 stands for loans given to person number one.
Net NPA is the amount that’s taken into account after the provision amount has been deducted from the gross non-performing assets.
Net non-performing assets = Gross NPAs – Provisions
Provision Coverage Ratio = Total provisions / Gross NPAs
Here are some measures that RBI has taken to prevent NPA:
All the necessary steps as mandated by RBI must be followed to ensure better functioning of Asset Reconstruction Companies.
Credit Information Bureau (CIB) helps prevent NPA by sharing information with defaulters.
In case of a loss, lenders can divide the loss through sales for a maximum of 2 years.
Corporate Debt Reconstructions provide extra time and lower interest rates for companies to repay, which reduces debt burden.
A Joint Lenders’ Forum must be set up to avoid situations wherein someone borrows a loan from one bank to repay another financial institution.
Special entities can participate in leveraged buyouts when they acquire stressed companies.
Banks must stick to a fixed timeline to plan for the resolution of loan defaults.
Non-Performing Assets (NPA) in banking impacts financial health of the lender as it hampers the revenue flow. Also, banks and NBFCs with staggering NPA numbers could come under RBI’s radar. Hence, it’s essential for financial institutions to come up with a tech-based customer check process that would help them reduce NPAs. Moreover, defaulting customers’ credit score is also impacted, which could make it difficult for them to secure a loan in the future.
Q1. What typically occurs when a bank declares NPA?
Ans: When a loan offered by a bank becomes an NPA, it has total authority to confiscate assets with the credit. These confiscated assets will be auctioned to repay outstanding loans.
Q2.What is a favourable NPA ratio?
Ans: Any NPA ratio below 1% can be considered as good or favourable for a financial institution.
Q3. What steps do banks use to recover non-performing assets?
Ans: To recover Non-Performing Assets, banks follow certain steps after the borrower fails to repay them. These are based on several laws, such as the SARFAESI Act, the Insolvency and Bankruptcy Code Bill, Lok Adalat and the Debt Recovery Tribunals.
Q4.Can an NPA account be reconfigured?
Ans: Yes, you can also reconfigure NPA accounts. However, existing asset classification rules that monitor NPA will stay the same..
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