What Is a Nonperforming Asset (NPA)?

NPA or non-performing assets (NPA) are defined by the Reserve Bank of India as any advance or loan that is overdue for more than 90 days. If the borrower fails to repay the loan or interest for more than 90 days as per schedule, the loan is classified as an NPA or a non-performing asset. NPAs are classified into various types depending on how long they have been non performing. 

Assets and Non-performing Assets For A Bank

An asset is essentially an owned entity, and in the context of banking, loans exemplify this definition. For financial institutions, loans qualify as assets owing to the substantial income generated through the interest payments made by borrowers. 

However, when clients, be they retail or corporate, encounter difficulties in meeting their interest obligations, the asset transforms into a 'non-performing' one. In such cases, the bank ceases to derive income from these loans, marking them as non-performing assets.

How Do Non-Performing Assets (NPA) Work?

When the ratio of NPAs in a bank's loan portfolio is higher, the bank’s income and profitability and capacity to lend falls. But, loan defaults and write-offs rise. To address this, the government and the Reserve Bank of India have launched various policies and methods to manage and reduce the amount of non-performing assets (NPAs) in the banking sector. 

Types of NPAs

As per the RBI mandates to banks, NPAs are broadly classified into 4 categories based on their repayment status. They are as follows:

1. Standard Assets - Standard assets are loans where the borrower is repaying the principal and interest in time.   

2. Sub-Standard Assets - These are assets where the borrower has defaulted for a period of 90 days or more. 

3. Doubtful assets - These are loans where the borrower has defaulted in repaying for a tenure of 12 months or more. 

4. Loss Assets - These are loans which the bank has identified as uncollectible and written off. 

NPA Provisioning

Provisioning means an amount that the banks set aside from their profits or income in a particular quarter for NPAs, such as assets which may turn into losses in the future. It is a ways in which banks provide for bad assets and make up for the losses. Provisioning is done according to the category of the asset. The categories have been mentioned in the section above. Provisioning not only depends on the type of bank but also on the type of asset. For example, Tier-1 and Tier-II banks have different provisioning norms. 

GNPA and NNPA

Banks cannot hide their NPA numbers. They have to make it public and show it to the RBI frequently. There are two metrics that help us understand a bank’s NPA situation.  NPA numbers for a bank will be specified in the standalone financial statements of a bank.

  • GNPA: GNPA expands to gross non-performing assets. It gives you the total value of gross non-performing assets for the bank in a particular quarter or financial year.
  • NNPA: NNPA expands to net non-performing assets. NNPA deducts the provisions made by the bank from the gross NPA and gives you the actual value of the non-performing asset. 

NPA Ratios

NPAs can also be written as a percentage of total advances. It gives us an idea of how much of the total advances cannot be recovered. The calculation is easy.

  • GNPA ratio is the ratio of the total GNPA to the total advances. 
  • NNPA ratio is the ratio of net NPA to the total advances. 

Factors That Cause NPAs

These are some of the reasons that cause NPAs

  • When banks lend to businesses or individuals without ensuring their credibility and even though they have poor credit ratings. 
  • When lenders don’t follow up on pending payments with borrowers in a timely fashion
  • Political pressure is there on banks, especially PSUs to lend to struggling sectors or industries.
  • Corruption in financial institutions (lenders) in connection with borrowers (Generally businesses).
  • Intefficient collection and recovery efforts by banks. 

How To Prevent NPAs?

  1. Lenders must scan the credit ratings of individuals or businesses when they are evaluated.
  2. Lenders must be proactive in sending reminders to borrowers, reminding them to pay the EMIs. 
  3. Lenders must offer payment plans and settlements to borrowers for regularizing their loan accounts. 
  4. Lenders may use other dispute resolution methods like Lok Adalats and Debt recovery tribunals to settle dues quickly 
  5. Lenders should be alert and strict with huge non-performing assets. 
  6. Lenders may use the services of professional asset reconstruction companies to handle their NPAs better.
  7. Lenders must pass around the details of defaulters, so that others hesitate to lend to these defaulters again. 
  8. Lenders should implement insolvency and bankruptcy policies to help struggling borrowers.
  9. Borrowers can use corporate debt restructuring.
  10. Lenders should be alert that borrowers (especially corporates) should not send their funds (loans) to other subsidiaries or startups. 

What is The Impact of High NPAs?

  • High NPAs may not be favourable for a bank, since they are assets that are not performing 
  • High NPAs mean that banks have several loans that have become non- performing or are not yielding any interest income to the bank.
  • Banks can either keep the NPAs in their accounting books hoping to recover it or write them off as bad debt. 
  • There are many other factors apart from NPA to assess a bank. 

Conclusion 

NPAs are a financial burden to the lender and too many NPAs over a period of time may reflect badly on the financial health of the bank. So, lenders should take all kinds of preventive measures to avoid NPAs. Also, they must make use of various options to recover these losses, including taking over of any collateral or selling off the loan at a good discount to a collection agency. 

FAQs

1. What happens to NPAs?

The bank or financial institution takes various steps to recover the funds from loan accounts categorized as NPAs. However, if the bank is unable to collect the funds, the loan account is written off, and the bank has to cover for the NPA through provisions set aside.

2. What are some of the common methods for NPA recovery?

Some of the common methods are DRTsand DRATs, Lok Adalats, Asset Reconstruction Companies, Prompt Corrective Action (PCA), and Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest Act 2002 (SARFAESI Act)