In line with the Reserve Bank of India’s (RBI) guidelines, an asset ceases to generate revenue for the bank is classified as a non-performing asset (NPA). As per the RBI’s criteria, any loan or advance that remains unpaid for over 90 days is labeled as a non-performing asset. Consequently, loans or advances that are in default or arrears fall under the categorization of Non-Performing Assets (NPA).
NPA Full Form
NPA, which stands for Non-Performing Asset, is a term used to describe a loan or advance where the principal or interest payment has been overdue for a period exceeding 90 days. Simply put, when a borrower fails to meet the scheduled repayment of a loan or interest for more than 90 days, that loan is categorized as an NPA. As of September 2022, as reported in the Financial Stability Report (FSR), Indian banks recorded a gross NPA of 5%.
Deciphering the Meaning of Non-Performing Assets (NPA)
A Non-Performing Asset (NPA) is characterized by an advance or loan where both the principal amount and interest payments are overdue by 90 days. According to the Reserve Bank of India (RBI), an asset turns non-performing when it ceases to generate income for the bank.
The term “asset” encompasses any valuable resource capable of being sold or converted into cash, providing financial benefits to individuals, businesses, and governments. Loans, regarded as assets for banks, contribute to their profitability through borrower-paid interest. When a borrower faces challenges in repaying the loan or defaults, the asset turns non-performing for the bank, as the revenue stream for that specific loan comes to a halt.
Understanding the Working Mechanism of Non-Performing Assets
Non-performing assets find their place on a bank’s or financial institution’s balance sheet. In the event of prolonged non-payment, the lender typically instructs the borrower to liquidate any assets pledged as part of the loan agreement. In cases where no assets are pledged, the lender may opt to write off the asset as a bad debt, subsequently selling it at a loss to a collection company.
The classification of debt as non-performing occurs when loan payments remain unpaid for a period of 90 days, adhering to the industry standard. However, this timeframe can vary, being shorter or longer based on the specific terms and conditions of each loan. Throughout the loan’s term and maturity, it may be designated as a non-performing asset.
Understanding Bank Concerns: Why an Account Turning NPA Raises Alarms
The banking sector grapples with unease over accounts evolving into NPAs for multifaceted reasons:
- Loss of Revenue: As an account transitions into a stressed state (NPA), banks forfeit the ability to levy interest charges.
- Reputational Impact: A surge in NPAs casts shadows on the bank’s brand image and standing, raising concerns about its financial credibility.
- Elevated Provisions: The shift of an account into NPA territory triggers specific RBI regulations, compelling banks to augment provisions at an accelerated pace.
- Market Turbulence: Inclusion in the NPA category may precipitate a dip in the bank’s stock market valuation, heightening concerns about market volatility and investor trust.
Consequences and Impacts of NPA in Banking
The predominant challenge facing modern banks revolves around the surge in Non-Performing Assets (NPAs), significantly impacting investor, depositor, and stakeholder confidence in financial institutions grappling with elevated NPAs.
- Financial Strain Caused by NPAs: The presence of Non-Performing Assets undermines a bank’s financial health, resulting in heightened losses. Furthermore, banks are compelled to allocate additional provisions, typically in the range of 25-30%, for NPAs, further diminishing overall profitability.
- Challenges in Managing Liabilities: Elevated non-performing assets force banks to contemplate adjustments, including potential reductions in deposit interest rates and corresponding increases in interest rates on advances. This intricate scenario markedly alters the dynamics within the banking industry.
- Securing Shareholder Trust: Shareholders prioritize the security of their investments, seeking assurance regarding monetary safety and prospects for investment growth and market capitalization. These pivotal factors shape shareholder confidence, establishing a profound impact on trust in the banking institution.
Exploring NPA Varieties
According to the directive from the Reserve Bank of India (RBI), banks are required to categorize their Non-Performing Assets (NPAs) into four groups based on their repayment status.
Standard Assets in Banking
Standard assets are loans and advances within a bank’s portfolio that satisfy all criteria for prompt repayment. These assets demonstrate consistent repayment patterns, with borrowers meeting their financial commitments as agreed upon. Designating an asset as “standard” in the banking realm signifies a low risk of default, thereby contributing to the overall robustness and well-being of the bank’s loan portfolio.
Sub-standard Assets in Banking Practices
Sub-standard assets in banking represent loans and advances with an elevated risk of default, often characterized by delayed repayments or financial strain experienced by borrowers. These assets do not meet the standard criteria for timely repayment set by banks, signaling an increased likelihood of potential losses. Designated as sub-standard, these assets require heightened scrutiny and proactive risk management measures to address and mitigate potential financial challenges.
Unraveling Doubtful Assets
Doubtful assets in banking pertain to loans and advances carrying a substantial risk of default, surpassing the concerns associated with sub-standard assets. These assets introduce considerable uncertainty regarding full recovery, prompting banks to classify them as doubtful due to a heightened likelihood of losses. This classification necessitates a meticulous examination, compelling the implementation of proactive risk management strategies to address potential financial challenges and mitigate adverse impacts on the overall financial health of the institution.
Exploring Loss Assets
Loss assets in banking refer to loans and advances with a significantly high likelihood of unrecoverable losses, surpassing the concerns associated with doubtful assets. This classification signals a situation where there is minimal to no expectation of recovering the outstanding amount. Banks designate assets as loss assets after exhausting all available avenues for recovery. Identifying loss assets triggers the implementation of stringent measures for risk mitigation, highlighting the financial challenges faced by the banking institution. Managing and addressing loss assets is paramount for safeguarding the overall financial health and stability of the bank.
How NPAs Affect Borrowers
Individuals experiencing loan defaults that result in the classification of Non-Performing Assets (NPAs) encounter noteworthy effects:
- Degraded Creditworthiness: NPAs lead to a substantial decline in a borrower’s CIBIL score, diminishing their overall creditworthiness significantly.
- Operational Implications for Entities: Borrowers and the entities under their purview face adverse effects, potentially causing operational hurdles for subsidiary companies.
- Impact on Borrowers’ Repute: The repute of borrowers may be tarnished as a consequence of NPAs, influencing their standing and credibility within the business landscape.
- Loan Approval Hurdles: Banks perceive accounts marked with NPAs as warning signs, instigating reluctance in approving future loans for such borrowers. Consequently, obtaining loans in subsequent endeavors becomes a formidable challenge for these individuals.
Calculating NPAs with Gross and Net NPA
Gross Non-Performing Assets (NPAs) constitute the total of outstanding loans recorded on a financial institution’s balance sheet. This calculation involves the formula: Gross NPA = (A1 + A2 + A3 … + An) / Gross Advances, where A1 represents loans extended to the first individual.
Conversely, Net NPAs represent the residual amount considered after subtracting the provision amount from the gross non-performing assets:
Net Non-Performing Assets = Gross NPAs – Provisions
To assess the effectiveness of provisions, the Provision Coverage Ratio is determined by:
Provision Coverage Ratio = Total Provisions / Gross NPAs
NPA Retrieval Methods
Here are various methods commonly employed for NPA recovery:
- SARFAESI Act (Securitization & Reconstruction of Financial Assets & Enforcement of Security Interest Act 2002): Leveraging legal provisions to enforce security interest in the recovery process.
- Debt Recovery Tribunals (DRTs) and Debt Recovery Appellate Tribunals (DRATs): Specialized legal forums dedicated to adjudicating and resolving disputes related to debt, facilitating the recovery process.
- Lok Adalats: Informal, alternative dispute resolution platforms utilized for negotiating and settling NPAs outside formal court proceedings.
- Asset Reconstruction Companies: Entities with expertise in acquiring and recovering distressed assets, playing a crucial role in the NPA recovery landscape.
- Prompt Corrective Action (PCA): Regulatory interventions imposed by central authorities on banks, aiming to address and rectify concerns related to capital and asset quality.
Conclusion
The presence of Non-Performing Assets NPA in banking sector has a significant impact on the financial well-being of the lender, disrupting the steady flow of revenue. Financial institutions, including banks and Non-Banking Financial Companies (NBFCs), with elevated NPA figures, may attract the attention of the Reserve Bank of India (RBI). Consequently, it becomes imperative for these institutions to devise technology-driven customer check processes to mitigate and minimize NPAs. Additionally, customers who default on payments may experience a decline in their credit scores, potentially creating hurdles for them in securing loans in the future.
FAQs
What are the usual consequences when a bank classifies an account as NPA?
Response: Once a loan extended by a bank transforms into a Non-Performing Asset (NPA), the bank holds the full authority to seize the assets associated with the credit. Subsequently, these seized assets undergo auctioning processes, and the proceeds generated are utilized to settle the outstanding loan amounts.
What constitutes a favorable NPA ratio in banking terms?
A Non-Performing Asset (NPA) ratio is deemed favorable for a financial institution when it falls below 1%.
What are the typical measures that banks adopt for the recovery of non-performing assets?
In the pursuit of recovering Non-Performing Assets (NPAs), banks initiate specific steps once the borrower defaults on repayment. These steps are typically aligned with various legal frameworks, including the SARFAESI Act, the Insolvency and Bankruptcy Code Bill, Lok Adalat, and the Debt Recovery Tribunals.
Is it possible to restructure or reconfigure an account classified as NPA?
Indeed, it is possible to reconfigure Non-Performing Asset (NPA) accounts. It’s important to note that while reconfiguration is feasible, the prevailing asset classification rules overseeing NPAs will remain unchanged.
