What are Non-Performing Assets in banking?

Non-performing assets (NPA) are loans or advances that are in default for an extended period. In other words, a loan is considered an NPA when the individual or corporation which has borrowed the capital fails to make the interest payment or instalments of the principal amount for an extended period. According to the Reserve Bank of India (RBI), any loans or advances that are in default or arrears for more than 90 days are to be declared as NPAs. Loans can be categorized as non-performing assets at their maturity or any point during the loan term.

RBI requires banks to declare their NPA account position to it and the public. Analysts can look at the Gross NPA (GNPA) and Net NPA (NNPA) numbers to assess the financial health of a bank or financial institution.

Gross NPA highlights the bank's total value of non-performing assets in a particular period. The ratio of GNPA to the total advances is the GNPA ratio. Net NPA, on the other hand, is derived by subtracting the provisions from the gross NPA. NNPA ratio is the ratio of NNPA to the total advances.

Provision is the capital set aside by the bank from its cash flow to make up for the expected losses from an NPA to maintain a healthy book of accounts. The RBI directs the provisioning norms. 

Banks can develop and implement their own policies with respect to recovering and writing off bad loans and negotiating settlements with such borrowers with the support of their board.

What leads to NPAs?

Here are some factors that can contribute to NPA:

• Aggressive lending by the financial institution without proper screening or appraisal of the creditworthiness of the borrowers
• When banks lend for projects that do not hold potential and are likely to fail
• The borrowing corporations redirect funds to other projects instead of repaying the bank
• Lack of proper infrastructure to share credit information between commercial banks
• A structural issue in the economy, like a recession or war, that leads to big borrowers going bankrupt
  
  

Impact of NPA on a bank’s financial health

A high level of NPAs in the banking system can compromise the lending capacity of banks, which can slow down corporate spending and result in sluggish economic growth in the country. Poor recovery of receivables and weak loan management policies can also lead to NPAs.

Banks may also have to resort to interest rate hikes to support their margins when NPAs increase.

The financial institutions may turn more risk averse with a greater focus on managing credit risk, hurting entrepreneurship in the economy.

Sub-Classifications for Non-Performing Assets

Banks categorise assets into the following major groups:

Standard Assets:

These are good assets that are regularly repaying interest or instalments and have a normal risk level.

Sub-standard Assets:

These are bad assets that have stayed as NPA for a period less than or equal to 12 months.

Doubtful Debts:

These are accounts that have been NPAs for over 12 months. These NPAs can cause serious damage to the bank’s risk profile.

Loss Asset:

These are bad loans with an extended period of non-payment and have been identified as a loss asset with little salvage value.

Conclusion

The Government of India and RBI have been taking initiatives to control the NPA issue as many NPA accounts raise red flags about the economic environment. Their efforts include several recent measures like the introduction of the Insolvency and Bankruptcy Code (2016), Asset Quality Review (2015), and Strategic Debt Restructuring (2015). A Statista report highlights that the NPA scenario is improving in India. According to this report, public sector banks in India together recorded non-performing assets valuing nearly Rs 6.17 lakh crore in the fiscal year 2021. The figure compares favourably with the NPA of around Rs 7.5 lakh crore recorded in the fiscal year 2019.

FAQ

Q. How can I finally settle my loan that has been declared as NPA?

One-time settlement (OTS) can provide support in settling NPA loans.

Q. What are the reasons for NPA?

Several reasons can lead to the generation of NPAs, including compromised loan management policy, failure to do a proper credit appraisal, business failures, etc.