Understanding Non-Performing Assets (NPAs) in the Banking Industry
In the banking industry, Non-Performing Assets (NPAs) refer to loans on which the principal and interest payments are long overdue. This means that the banks have not received regular payments for those assets. NPAs are also known as bad or distressed assets, as they do not generate the expected returns.
What are Non-Performing Assets?
Non-Performing Assets are financial assets that fail to generate income for the lender due to loan defaulting or delinquency. These troubled assets could be bonds, loans, mortgages, credit card debt, and so on. According to the Reserve Bank of India (RBI), when any advance or loan becomes overdue for 90 days, it becomes an NPA.
Having NPAs on the balance sheet is not a good sign for any financial institution as it has a negative impact on its financial condition. Banks cannot meet the stringent regulatory requirements of the RBI with NPAs on the balance sheet. To reduce NPAs, lenders take borrowers to court to liquidate the borrower’s pledged assets. If no such assets are available, the lender writes off the loan as bad debt. In some cases, banks may sell these NPAs at a discounted rate to a collection agency to remove them from their balance sheet.
In India, the uptick in economic activities, restructuring of stressed units, and a robust recovery network have helped banks lower their NPAs by 77% in the last six months. This is a positive sign that strengthens financial institutions.
Types of Non-Performing Assets
The RBI has issued guidelines on the classification of NPAs by banks. The following are the different types of NPAs:
1. Standard Assets
Standard assets carry normal business risks and are not problematic to the lender. Assets that have been overdue for 90 to 120 days are considered standard assets.
2. Sub-Standard Assets
Sub-Standard assets carry slightly higher risks than standard assets. Financial institutions are more likely to suffer a loss if they don’t rectify deficiencies with this type of asset. Typically, these assets are overdue for about 12 months.
3. Doubtful Assets
Doubtful assets are those where the banks’ chances of recovering the assets are very low. If the assets have been overdue for at least 18 months, the doubts regarding their recovery are almost always justified. Banks are likely to face losses as the liquidation of these assets is highly doubtful.
4. Loss Assets
Loss assets are those that financial institutions cannot wholly or partially write off as non-performing assets. These assets are declared uncollectible and do not have value as bankable assets. However, they may still have residual recovery value.
Significance of Non-Performing Assets
Dealing with NPAs is challenging for banks due to the following reasons:
1. Financial Losses
NPAs result in financial losses for banks, indicating a potential failure to recover the principal and interest. With higher NPAs, banks have to set aside larger provisions.
2. Liquidity Impact
NPAs lock up a bank’s funds and affect its liquidity. This can hinder the bank’s ability to lend to other borrowers or meet its financial obligations.
3. Credit Rating Downgrade
Higher NPAs raise red flags for lenders, and the bank’s credit rating may be downgraded. A lower credit rating can make it more difficult and expensive for the bank to borrow funds.
NPAs also pose challenges for borrowers:
1. Adverse Credit Score
The credit score and creditworthiness of borrowers whose loans have been converted into NPAs will be adversely affected. This can make it harder for them to secure future loans or credit.
2. Legal Proceedings
Banks initiate legal proceedings to recover NPAs, which can affect the borrower’s other assets and financial stability.
3. Difficulty in Obtaining Additional Financing
Borrowers with NPAs will find it challenging to obtain additional financing as lenders may view them as high-risk borrowers.
NPA Provisioning
Financial institutions lend money to borrowers after careful consideration. However, despite all measures to recover loans, NPAs are sometimes unavoidable. To account for this, every bank or lending institution declares a portion of its income or profits to cover NPAs. This process is called NPA provisioning, which allows banks to maintain a healthy balance sheet.
NPA Parameters – Gross NPA and Net NPA
When assessing NPAs, two key parameters are considered:
1. Gross NPA: Gross NPA is the total amount of NPAs held by a bank without considering provisions made against them.
2. Net NPA: Net NPA is the amount of NPAs after considering provisions made against them. It reflects the actual loss that the bank may incur due to NPAs.
In conclusion, non-performing assets pose significant challenges for both banks and borrowers. They impact the financial health of the bank, its ability to lend, and the creditworthiness of borrowers. Proper management and provisioning for NPAs are crucial for maintaining a stable banking system and protecting the interests of all stakeholders.